Goldman Sachs (GS) , in its April report, said that the shale gas boom was going to bring in $57-$65 billion in investment over the next five-seven years across five key areas:
- Gas processing.
- LNG exports.
- Gas power.
A boom in these areas means a boom in the U.S. engineering and construction (E&C) industry. Given the potential for a multi-million investment cycle, Chicago Bridge & Iron (CBI) and KBR Inc. (KBR) are expected to be the main beneficiaries.
Although natural gas prices have risen sharply in the last three-four weeks, gas remains far cheaper than oil as an alternative fuel source.
Gas processing is required to remove natural gas liquids (NGLS), water and contaminants from gas in order to purify it for consumption purposes. An increase in production in liquid-rich shale regions means more gas processing activity expected in the future. It is postulated that around $10 billion of investment is required to set up the infrastructure in order to match future demand. The increased spending will be driven by NGL drilling, LNG exports, gas power demand and new ethane capacity. Both CBI and KBR are expected to benefit from the situation in light of the recent gas processing projects that they have been working on. Some of the projects are: Columbiana Processing County Plant in collaboration with Chesapeake (CHK), M3 midstream and EV Energy; Another project is the construction of a gas processing plant in British Columbia.
NGL fractionation is the process by which mixed NGLs like ethane, butane and propane, are separated into distinct products. In order to address the supply bottleneck, $4-$6 billion of investment is likely to be attracted, by this segment in particular. Ethane, in particular, is used extensively in the petrochemical industry. Also, NGLs are used in motor fuels and in heating. Again, given their experience in projects in the relevant field, CBI and KBR hold a genuine chance to secure most of the investment.
Rising gas supply means cheap NGL supply, which, in turn, means cheap ethane. Therefore, cheap ethylene supply will eventually be used to replace the costly naphtha and propane, and, thereby, bringing cheap feedstock for the companies. Ethylene production expansion plans will require $3.5-$4.5 billion. Again, the recent ethylene technology contract for William Geismar, which CBI has won, and KBR's ethylene furnace construction project for INEOS Chocolate Bayou, gives the market a hint that both companies will benefit from the new projects.
New ethylene crackers worth $15 billion are also expected to be constructed in the next couple of years. It is important to remember that no new cracker has been constructed since 2001. Four of them with the highest chance of being constructed are Formosa's Point Comfort project, Chevron Phillips (CVX) project in Cedar Bayou, Dow Chemical's (DOW) Gulf Coast Project and Shell's (RDS.A) project in Pennsylvania with Horsehead Corporation (ZINC).
Before we discuss the beneficiaries of the rise in LNG exports, it is important to state that it is a confusing situation, given that LNG exports will lead to less supply of gas within the U.S. and, therefore, a hike in prices will ultimately kill the advantage that consumers look for when switching from oil to natural gas. Therefore, although selected companies will benefit from their involvement in the construction of LNG export terminals, in the long-run, they might be at a disadvantage as gas prices may rebound, hindering any further investment in the E&C development relevant to the shale gas boom.
Future LNG exports depend on two prime drivers:
- Spread of LNG prices in the U.S., and worldwide.
- International demand for LNG due to solid energy growth demand.
Given the current scenario, there is a potential for 12 LNG export terminals to be built. However, at least three will be built that are likely to attract $11-$14 billion. Three projects are Sabine Pass, headed by Cheniere Energy (LNG), Kitimat LNG, which is expected to be awarded to KBR, and Freeport LNG, which is expected to be awarded to CBI. Foster Wheeler AG (FWLT) is also expected to be a beneficiary.
Coal-to-gas switching has been on the rise after the decline in natural gas prices. Coal retirements are expected to increase as gas prices tumble, or if users feel that there is a significant gap between both the prices to take advantage from the divergence. In order to cover that, new gas generation will be required. Around $14-$15 billion are expected to be invested in this field. SHAW Group (SHAW) is already working on Entergy's Ninemile Point combined cycle plant, and is expected to be a main beneficiary. CBI, through SHAW's acquisition, will be able to benefit from the rise in investment in this sector.
CBI topped earnings estimates in its last quarter's earnings release. Its book-to-bill ratio was 1.41, much higher than the street's estimate of 0.9. Awards were hefty as well, at $1.8 billion. A margin of 7.7% was also above expectations. CBI raised its 2012 EPS guidance from $2.4-$2.5 to $2.85-$3.05. The company's Lummus Tech project is its main strength.
Back in June, CBI announced to buy the SHAW group for $3 billion. Despite a 15% fall in CBI's stock on the day of the announcement, the market seems to be bullish about this acquisition. SHAW's inclusion will help CBI strengthen its direct construction business and help it win big projects. The SHAW group also enjoys a large market share in nuclear maintenance-related work, which CBI can exploit after the acquisition.
With so many bullish signs emerging in favor of the stock, the cheap valuations at which CBI is trading, and a dividend yield of 0.5%, it is recommended as a buy.
KBR posted 2Q2012 EPS of $0.7, which was way higher than the street's estimate of $0.5. The book-to-bill ratio of 0.75, however, missed expectations. For the remainder of the year, KBR is expected to earn from the Skikda Project and the Ichthys Project in the Northern Territory of Australia. KBR's earnings will also go up, after it ramps up its service and power segments.
KBR raised its EPS guidance from $2.45-$2.8 to $2.6-$2.8. With multi-million dollar investment expected in the E&C sector, the cheap valuations at which KBR is trading, and a dividend yield of 0.7%, the stock is recommended as a buy.