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Value oriented, event-driven, industrial focused.
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  • U.S. Gulf Coast Mid-Stream And Petrochemical Renaissance To Increasingly Boost Seaborne Trade? 0 comments
    Nov 6, 2013 7:06 AM

    The American unconventional hydrocarbon revolution has gained momentum in popular media over the last year. Headlines declaring that the United States have overtaken Saudi Arabia and Russia in petroleum production becoming an everyday occurrence. I wrote a detailed dissertation on the topic last year, which is available here.

    A lot of the predictions that were presented in the analysis are starting to come to pass, with EIA's latest weekly crude oil statistics showing a year-to-date production increase of 1.286 mb/d (+19.5%) and decrease in imports of 1.167 mb/d (-13.2%). Meanwhile, the somewhat laggy natural gas data showed is showing a gradual upward development with dry gas production reaching 69.2 bcf/d for July. 2013 is poised to be an all-time-high year for gross gas withdrawals since 1972, with recent report suggesting record production from Texas' mature heavyweight Barnett Shale and its younger Appalachian brother, the Marcellus Formation. The latter has grown to an impressive current-day production of 7.5 bcf/d - a mere couple of billion cubic feet less than Norwegian output - from 400,000 mcf/d in 2010.

    The petroleum production increase provides companies catering to the petroleum industry, from the wellhead to the consumer, with an abundance of lucrative business opportunities. Moreover, the trickle-down effect of the increased petroleum related activity is witnessed throughout the economy, by bringing down the cost of energy, creating jobs and increasing tax revenues.

    New intrastate pipelines along with additional gas treating, processing, and fractionating plants are frequently announced. Because of the infrastructure expansion, service and manufacturing sectors throughout the country is benefiting. Be it, suppliers of rail equipment, steel mills, engineering firms, industrial contractors, truck manufacturers, down to the niche of mining specialized fracking sand.

    Gas still cheap:

    In contrast, natural gas producers such as Chesapeake Energy (NYSE:CHK) are not rubbing their hands, with the presently suppressed natural gas prices making production scarcely economic, urging drillers continue focus on liquid rich shale plays. Due to the low prices, infrastructure constraints and transportation bottlenecks, considerable parts of the associated gas is considered an unwanted by-product and is actually flared off. This is especially true in North Dakota and Wyoming.

    The activity increase is particularly visible in the mid-stream petroleum sector, with a record surge in investments in pipelines, railroads, trucks and barges. The (former) substantial price differentiation between the landlocked Midwest crude and Oklahoma-delivered West Texas Intermediate (which again has traded at a $10-$20 discount to the global de-facto benchmark, North Sea Brent) has spurred arbitrageurs to move crude to coastal states in the South and East (where Brent prices are attainable). Today, in excess of 1.4 million barrels of oil is transported by rail every day.

    Meanwhile, there has been a transformation in the mid-stream segment, with pipeline operators becoming more integrated with activities including processing, treating, fractionating and storage of gas and liquids. The biggest names in the industry include Enbridge (NYSE:ENB), Spectra (NYSE:SE), Enterprise Product Partners (NYSE:EPD), Williams Companies (NYSE:WMB), Kinder Morgan (NYSE:KMI) and Energy Transfer Partners (NYSE:ETP), which all have valuations north of 20 billion dollars and a collective market capitalization of $257 billion. To put that in perspective, it is the equivalent of 83% of the Oslo Børs Benchmark Index' (OSEBX) value. Moreover, the 62 company strong Dow Jones U.S. Pipelines Index (DJUSPL) is up by 256% since the beginning of 2009, outperforming the broad S&P 500 Index by over 150%.

    Refining renaissance:

    Another characteristic of the mid-stream bonanza, is the increased activity in the refining sector. The capacity utilization has surpassed 90% with previously shuttered plants being brought back on-line, and even urging building of new refineries for the first time in the country in 35 years. Two of them have broken ground in North Dakota and one is expected in Utah.

    Texas, with its oil rich history, has 27 refineries by itself and is together with its Gulf Coast neighbors the largest global refinery center with a total processing capacity of about 9.6 mb/d (more than half that of the whole country). Gulf Coast refiners are largely set up to accept heavy and sour crudes (traditionally sourced from Mexico, Venezuela and Saudi Arabia), but many are opting to re-gear their facilities to accommodate the lighter, sweeter and cheaper domestic crude.

    The extensively watched WTI-Brent spread has widened back to around $10 per barrel, coupled with the improved infrastructure making the inland crude more easily available, has led to favorable crack spreads (margins) for USGC and Midwest refiners. Refiners are selling gasoline, diesel, kerosene and other distillates at prices linked to the more expensive Brent. Moreover, with the low price of natgas feedstock, direct access to the biggest domestic oil products market and deep-water port facilities, they can export to any part of the world at the highest prevailing prices. While its European refinery counterparts are running at a meager 78% capacity and struggling to earn 125 cents on the output of a barrel, U.S. refineries with traditional delayed coker design has been able to rake in upwards of $18/bbl. Valero, the world's largest independent refiner, has spent $3 billion on new hydrocrackers for two of its USGC refineries and is reporting of an internal rate of return (NYSE:IRR) in excess of 30% for such bolt-on upgrades.

    The improvements in competitiveness, together with declining domestic demand, has made the United States the largest exporter of petroleum products in the world, with July (the latest available data) marking an all-time-high of 2.68 mb/d (up almost 50% from 1.43 mb/d in 2009) worth of exports, the bulk of which (1 mb/d) is diesel and fuel oil.

    New York-listed Scorpio Tankers (NYSE:STNG) showed prescient when observing the above-mentioned trend, and acting accordingly by essentially cornering the newbuilding market for vessels that transport petroleum-derived products. The company has ordered a whooping 54 tankers, with sizes from Handymaxes to LR2s, occupying the best build slots at tier-one Korean shipyards until 2015. Together with its 48 owned and chartered-in vessels, the fleet counts 102 and constitutes 6.42 million deadweight tons, making Scorpio the world's largest product tanker owner.

    Norwegian equities:

    However, opportunities are not limited to offensive domestic companies. Several Norwegian based/listed companies have already benefited handsomely from the development, and may be poised to continue to do so. Hexagon Composites (HEX), Solvang (SOLV), Aker Philadelphia Shipyard (AKPS), Odfjell SE (ODF) and Stolt-Nielsen (NYSE:SNI) are some of which are favorably positioned.

    The Jones Act cabotage laws - which prohibit domestic seaborne transportation with vessels that are not U.S. flagged, crewed, owned and built - has pushed day-rates for such tankers upwards of $70.000. This in turn, is responsible for the distorted trade-flows wherein USGC petroleum exports typically heads south to Mexico and Latin America, while refined products from Europe or Canada supply the East Coast. Aker Philadelphia Shipyard - a previously struggling company facing potential bankruptcy - now stands as one of two shipbuilders with the capability to build Jones Act compliant tankers, and its stock has seen an unprecedented 488% gain this year.

    Hexagon manufactures composite pressure vessels and storage systems for LPG and CNG, both in Norway and Nebraska. The company is doubling the production capacity of its U.S. product line, as higher demand has increased annual revenue 81% as per third quarter. The HEX stock is up 253% since the beginning of the year. In its latest report, the company points to the U.S. heavy-duty vehicle market as being positioned for "exponential growth".

    The Stolt-Nielsen name is no stranger to Norwegian households. Credited for being the inventor of the parcel tanker, the firm was established in 1959 and is the world's largest owner and operator of chemical tankers. Chemical tankers are smaller than most tankers and carry hundreds of different chemicals, including alcohols for solvents, aromatics for paints and sulfuric acid for insecticides. The U.S. is the largest exporter of organic chemicals, accounting for about a quarter of global volume.

    In its latest quarterly report, the company is cautious about the market outlook for its vessels, and states that it has not seen an increase in U.S. volumes "despite talk of the potential impact". The company has become more integrated and branched into tank farms and distribution (Stolthaven Terminals) and leasing operations of tank containers (Stolt Tank Containers), both of which are poised to do well in the wake the shale development. The stock has returned 47% this year, but has higher analyst exposure and healthier liquidity than the others in mention.

    Foresighted investors have had excellent opportunities to take advantage of U.S. shale exposure through positioning themselves in the aforementioned equities. Similar analysis was likely the background for superstar value investor Warren Buffet's acquisition of Burlington Northern Santa Fe Corporation at the end of 2009, and specialty chemical manufacturer Lubrizol Corporation in 2011.

    Solvang ASA, the operator and (partial) owner of 17 LPG/ethylene carriers, is well positioned for increased demand for said tonnage and may be next in line for a stock price boost. There has already been large-scale consolidation and M&A activity in the segment, with NOTC-listed entrant Dorian LPG (DORIAN) teaming up with Scorpio, and Avance Gas (AGHL) formed by Fredriksen-controlled Frontline 2012 (FRNT), Stolt-Nielsen Gas and Sungas Holdings. Additionally, the largest LPG shipowner, BW Gas, is expected to (re)list on the Oslo Børs at the beginning of 2013 with a plan to raise upwards of $200 million in new equity for further growth.

    Maritime service providers and brokerages are also expanding, with Norwegian gas specialist shipbroker Inge Steensland setting up a subsidiary in Houston expected to open early next year.

    Natural gas liquids:

    An aspect of the hydrocarbon production revolution that thus far has not received much scrutiny is natural gas liquids (NGLs) and liquid petroleum gases (LPGs). NGLs and condensates are components of the natural gas stream that are liquid at surface, and include propane, butane, pentane, hexane and heptane. There are many uses for NGLs, spanning many sectors of the economy, but the majority is consumed by the petrochemical industry. The petrochemical sector is a $770 billion industry, providing 784,000 jobs, holding 17% of all patents and constituting 12% of U.S. exports. Equally importantly, it provides the public with products essential in manufacturing plastics, paints, building materials, clothing, fertilizers, automotive parts and a range of other consumer and industrial products.

    Much like its gaseous brother, NGLs are equally inexpensive and substantially cheaper than in other global markets. In 2012, gas plant NGL production averaged 2.4 million b/d, up 8% from 2011. Energy banking specialist, Simmons & Company, estimates potential NGL production to rise to 2.76 mb/d (363,000 b/d) for this year and 3.34 mb/d (581,000 b/d) in 2014 - almost double Norway's crude oil output for 2012.

    Whereby European and Asian ethylene producers mainly are set up to use more expensive oil based products, such as naphtha - the price discrepancy is a gift to domestic industry players. With the current glut of ethane, and prices hovering around 40 cents/gallon, it costs around $450 to make a ton of ethylene. This compares to about $1,250/ton for producers using naphtha, assuming an oil price of $90/bbl. Ethylene account for 40% of global chemical trade and is an essential building block in the making of plastics.

    Therefore, it is no surprise that American Chemistry Council is reporting of 17 separate ethane cracker plant projects, brownfield/expansion or greenfield, planned or under consideration. Propylene, also a by-product from ethane cracking, is the second most important starting product in the petrochemical industry and has seen a drop in production due to the shift away from naphtha feedstock. Accordingly, the industry is adapting and dedicated propane dehydrogenation (NYSE:PDH) plants are starting to pop up. These plants processes propane into propylene, but has previously not been economically viable because the price gap between the two gases have historically been low. With the price of propane coming down from its $2/gallon highs in 2008, the spot price as of yesterday was $1.17 delivered FOB Mont Belvieu. Mont Belviue in Texas is the main storage hub for NGLs, similar to what Cushing (Oklahoma) is to crude and Henry Hub (Louisiana) is to NG.

    PetroLogistics (PDH) is a Houston-based niche player that acted on these market conditions taking note of the tight propylene supplies. It has been running the largest PDH plant in the world (544,000 tons/year) since 2010 and opted to perform an initial public offering in May last year. Further five plants have been announced in the Texas-area with a collective annual capacity of 5.1 million tons.

    Supermajor stronghold:

    The development has not only been getting attention from smaller players, with big names like Dow Chemical (NYSE:DOW), LyondellBassell (NYSE:LYB), ExxonMobil (NYSE:XOM), DuPont (NYSE:DD) and Phillips 66 (NYSE:PSX) all expanding their NGL derived petrochemical activity. It is in fact also luring foreign chemical giants, such as Anglo-Dutch oil major Shell (RDSA), Germany's Bayer AG (OTCPK:BAYN), São Paulo-based Braskem (BRKM3), South-African Sasol (OTCQB:SASOF) and Saudi SABIC, whom together reportedly have committed over $100 billion in investments in the sector.

    If the increased supplies of propylene and ethylene does not find its way into the local industry, it will likely be sent overseas and could therefore give chemical tanker rates a deserved boost. This would potentially benefit Norwegian shipowners with this type of tonnage, mainly Stolt-Nielsen (SNI), Eitzen Chemical (EICHEM) and Odfjell Tankers (ODF).

    Exports of NGLs and refined products does not face the same regulatory hurdles as crude, making the case for readily available LPG a strong one. With NGL pipeline capacity expected to increase by 2-2.5 million b/d during 2013-15, along with 1.4 million b/d (54% increase) of fractionation capacity to come online in the same time period, the case for exports is a strong one. Both Phillips 66 (PSX) and Enterprise Product Partners (EPD) recently announced plans for new LPG export terminals at the Houston Ship Canal, with 4.4 and 6.5 million barrels per month capacity respectively - the equivalent of almost 20 very large gas carriers (VLGC). This bodes well for pure-play VLGC operators Avance Gas (AGHL), Dorian LPG (DORIAN) and their more diversified peer, Solvang ASA (SOLV).

    With the intense competitiveness of the United States' energy environment, one will likely see a gradual equalizing of gas/liquids/chemical prices as infrastructure advances and traders monetize on arbitrage opportunities. However, long-term fundamental prospects are very sound, with industries and sectors across the economy poised to benefit from the cheaper energy.

    Energy superpower:

    The resurgence in petrochemicals and the resulting gas demand will likely be competing for supplies with utilities, transportation, manufacturing, as well as exports of both LNG and NGL. Yet, consensus among analysts paints a picture of continued abundance of NG supplies. Factors beyond low-cost feedstock, such as value-adding characteristics, strategic location, strong international demand and industrial symbiosis, has evolved the country into the (once again) world-leading petrochemical and specialty chemical centre, likely soon to be rivaling cost levels of subsidized Middle Eastern producers.

    Given the expansion project of the Panama Canal expected to finish by 2015 and United State's strategic location bordering the two largest oceans, makes commodity thirsty markets in Asia and Latin America easily accessible by seaborne transport. Having formerly been carrying the title the "breadbasket of the world", due to the country's widespread exports of corn and wheat, United States may now be underway to evolve into the "oil refiner and petrochemical maker of the world".

    At today's run-rate, diesel exports alone are generating revenues exceeding that of El Salvador's GDP (~ $50bn p.a.). Furthermore, the U.S. logged a trade surplus of $800 million in chemicals last year - the first time since 2001. Longer term, the exports of hydrocarbon-derived gases, chemicals and products will likely be of considerable importance in improving the country's trade deficit. Some industry sources suggest specialty chemicals alone will generate a $46 billion trade surplus by 2020.

    One investment bank has calculated that the natural gas price differential may provide an additional 1.5 percentage points of GDP output relative to Europe each year, assuming the disparity persists. In any case, the development will continue to be of crucial support for the world's largest economy, which is undergoing an undisputed fragile macroeconomic recovery.

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