So a few months ago I gave an analysis on Cheniere Energy (NYSEMKT:LNG). I knew that previous analysis was just missing one thing, and that was an itemized breakdown of the costs of liquefaction and shipping. I included that itemization in the previous article; however, I did not stop looking at the company or the industry after publishing. The reason I feel I must go over the company a second time is for two reasons. First, after more research, I found better figures for cost estimates. A miscalculation of even a single penny alters their profit by $10 million annually. Secondly, the markets have been very busy changing the U.S. oil and gas landscape, which can meaningfully impact the value proposition of Cheniere.
Production of LNG Rundown
Cheniere will have 2 locations where they produce LNG for sale into Europe. Sabine Pass and Corpus Christi will produce a total of 31.5 Mtpa. Sabine Pass will produce 22.5 Mtpa and Corpus Christi will produce 9 Mtpa.
It will help us to convert these "Mtpa" units into an easy unit like "mmBtu" which is the price measured by market hubs around the world. 31.5 Mt per annum is equivalent to 1.55 billion mmBtu. The production attributable to Sabine Pass is 22.5 Mt per annum, or 1.1 billion mmBtu. Corpus Christi will produce 9 Mt per annum, or 443 million mmBtu.
I am going to separate these into the "Deal" capacity and the "Spot" capacity because these are the two ways they will sell their product and each have unique properties for which we must account. First, the deal portion of the capacity can be easily calculated. The sales deals Cheniere made for the Sabine Pass plant follow a simple formula. The buyers pay Cheniere a fixed fee of $3 per mmBtu plus 115% of Henry Hub price. Cheniere is selling 973 million mmBtu under the deal contracts, which grants them $5.1 billion in revenue.
The sales contracts made for the Corpus Christi plant follow the following formula: 115% of Henry Hub plus $3.50 per mmBtu. They have sold 87% of their production here under these contracts, which equates to 7.7 Mt per annum, or 379 million mmBtu. The Corpus Christi contracts will generate $2.2 billion in revenue.
The spot capacity at both locations is going to be sold to the highest priced, closest market they can reach. For years, that has been the Asian market for natural gas, which has commanded a hefty premium over European natural gas prices. Previously, it was very difficult for Gulf Coast LNG to get to Asia since most ships that transport LNG could not fit through the Panama Canal, and the alternatives make the trip very unprofitable. Fortunately, for American LNG exporters, the Panama Canal authorities have been expanding the canal to fit larger vessels. More specifically, the canal can now fit over 80% of the LNG fleet, only unable to ship 2 of the biggest model LNG ships. After requests to allow those bigger ships through, the Panama authorities decided that after a few years of mastering safety of operations, they would likely allow those larger ships to pass through the canal.
The implications of this canal expansion are huge for North American LNG, since the biggest LNG markets exist on the pacific side of the United States. Japan and South Korea comprise 54% of the worldwide LNG market, as importers. Japan shut down nearly all their nuclear power plants following the Fukushima meltdown, and after engaging in further safety inspections, found multiple sites with similar risks. Japan wants to exploit nuclear power, but current public sentiment is tough, which will delay the restart of many Japanese reactors. In the interim, Japan must import the balance of in LNG. This is also fantastic for U.S. LNG exporters since they can command a price premium in those Asian markets.
The current LNG import price is $8.75 per mmBtu, so if Cheniere sells all their spot market Sabine Pass capacity to this market, they can make an additional $1.1 billion in revenue by selling 133 million mmBtu. Corpus Christi will produce 64 million mmBtu for the spot market and can make 400 million in revenue. Obviously, selling to Japan will incur more costs, so we must rundown those costs to find the profitability.
Total revenue for Cheniere from both plants will come to $8.9 billion annually.
This is the section I expect to be far more accurate than the previous article with more information. I will flesh out the "Deal" section first. The 973 million mmBtu Cheniere will sell to Europe from Sabine Pass and the 379 million mmBtu from Corpus Christi will incur the following costs.
$.32/mmBtu for transport of the natural gas feedstock through pipelines to the Sabine Pass Liquefaction facility. This is for an uninterrupted 300 mile pipeline trip to the facility. Should the facility need to source its huge quantities of natural gas from another source farther away, that would further contribute to the pipeline transportation cost.
The best analysis I could find for the cost of liquefaction estimates total liquefaction cost at $1.15 per mmBtu. Of this number, I was initially shocked that the variable costs for the actual liquefaction only amounted to approximately $.43 per mmBtu. The rest are fixed costs covering financing for the construction of the plant. This means that even if natural gas price differentials between regions were to compress significantly, Cheniere would be best suited by continuing to produce at full throttle to recover at least a portion of those financing costs. Remember, we are trying to get these numbers as close to real costs as possible, since even a single penny off will set our profits or revenues off by up to ten million dollars.
Shipping costs also contribute significantly to our total costs. The voyage for an LNG carrier from the Gulf Coast to Europe runs Cheniere approximately $1.20 per mmBtu. The trip to Japan costs more, at $2.20 per mmBtu. It is unclear if this figure for shipping to Japan includes passage through the newly widened Panama Canal.
Fortunately for Cheniere, they have made contracts with nearby producers of natural gas to get their feedstock at a discount to the Henry Hub price. Cheniere purchases its natural gas for $.10 less than Henry Hub.
So, for the "Deal" section of our costs, we get a per mmBtu cost at $4.67 per mmBtu, including the purchase of the feedstock, pipeline transport, liquefaction, and shipping. The "Spot" section could be different based on where Cheniere decides to ship the remaining LNG. I expect them to sell it to the island Asian nations I previously described in this article. Based on that, shipping will be significantly more than it was for Europe. Shipping to Japan will push costs to $5.67. Sabine Pass' spot sales will contribute $700 million to costs, while Corpus Christi spot sales will contribute $400 million.
Total costs from both plants will come to $7.3 billion.
Profit should equate to $1.6 billion for all operations.
Cheniere could face supply issues, depending on the ability of Texas fields to continue producing natural gas. The boom in natural gas supply in the United States has allowed prices for the commodity to fall considerably. There are some third party analysts that claim breakeven for American natural gas producers is $4 per mmBtu. That could very well be true, but I see most American supply as a byproduct from producing shale formations for oil. Most oil companies would drill for the intent of producing oil to sell on high priced oil markets and gather natural gas to sell on the side to subsidize their own production of oil.
In current market conditions, high-priced oil is gone, definitely for the short term, and most likely for the long term too. In this case, the crossover effects could be severe. With intense depression in both oil and natural gas commodity prices, there might be no reason for current producers to continue producing. I hope they are able to navigate this challenging landscape; however, I still must bring attention to important conditions.
I do not see Cheniere's customers as a risk, however. All of Cheniere's customers are investment-quality companies and utilities, and any subsidiary companies list their parent company as a guarantor.
Discounted Cash Flow Analysis Results
At an 8% cost of capital, we can easily calculate the present value of all future cash flows for the next 20 years, since we have a very consistent cash flow schedule. Entering this information into excel returns a company value of almost $14 billion, and a per share value of $48. Current equity prices for this company are around $28, so this indicates the company is 41% undervalued and should appreciate 71% over the next 2 years as the company begins production at most of its trains and the market realizes the value that this company holds.
Cheniere Energy is considerably more attractive than I had previously believed. Newly updated information and a more complete understanding of the fundamentals of this business have me agreeing with activist investor Carl Icahn, who has been doubling down and purchasing more of the company. The source of the last article's shortfall in accuracy was due to a lack of accessible information on the source of the costs due to liquefaction. Previous analysis used a figure between $1.00 and $1.50, which includes cost of capital. Not understanding this was already included, I then did an analysis on the debt, including the interest payments, an error I expect has been repeated by many, as evidenced by the fall in the stock price recently. After significant research, I found this error, and I present an updated analysis of the company with updated figures.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.