LNG Giant
During BG’s conference call to discuss its 2010 results and annual strategy update, CFO Ashley Almanza emphasized how the firm’s uncontracted supply enabled it to take advantage of record LNG demand in Japan and South Korea, a product of the economic recovery and favorable weather conditions during the winter and summer months:
Let’s take a look at LNG. During 2010, we saw demand recovery especially in Asia. And this was coupled with good weather-related demand during the course of the year. In these conditions, we are able to use our flexible supply chain and our market knowledge to divert cargos to high value markets. As a result, we posted operating profit of $2.2 billion in our shipping and marketing business.
Although BG doesn’t disclose what percentage of its LNG output hasn’t been sold under contract, in 2010 the company shipped 215 LNG cargoes on the spot market, 55 of which were destined for the US, the market of last resort. The company may remain mum on its uncontracted supply, but last year’s results suggest the company has the scope to allocate additional cargoes to Japan.
Over the longer term, the disaster in Japan and damage to the Fukushima nuclear power complex could impede further expansion of the country’s nuclear capacity, forcing the nation to increase its reliance on imported LNG.
In the wake of any crisis, investors invariably scramble to identify investment opportunities–either names that will benefit from resolving the disaster or names that were oversold in the ensuing panic. Provided that investors remain calm and closely scrutinize these opportunities, an overwrought market furnishes ample opportunity for future profits. For example, investors who purchased stocks leveraged to deepwater exploration and production (E&P) after the Macondo oil spill–a strategy we outlined in Opportunity amid Crisis–enjoyed substantial returns.
But BG’s growth story doesn’t hinge entirely on developments in Japan. BG operates three business segments–LNG, exploration and production (E&P) and transmission and distribution (T&D)–each of which offers exposure to a number of near- and long-term catalysts.
Source: Bloomberg
The firm’s LNG operations, which include liquefaction and re-gasification assets as well as the purchase, shipment, marketing and sale of LNG, accounted for roughly 35 percent of the company’s 2010 revenue. This makes LNG BG’s second-largest operating segment, but we’ll begin our analysis here, as much of the recent scuttlebutt has focused on this business line’s growth prospects.
LNG
BG’s LNG operations and assets span the globe and, in many instances, complement its E&P efforts:
- A 50 percent stake in the Dragon LNG import terminal in Wales, with a 20-year arrangement that will receive up 2.2 million tons per annum (mtpa) of LNG from BG. The company uses this capacity when UK prices are attractive relative to other markets.
- An interest in two 3.6 mtpa liquefaction trains at Idku, Egypt, which BG supplies with natural gas from the West Delta Deep Marine concession. The company also purchases the output from the second train for its flexible LNG portfolio.
- A 14.25 percent ownership in the Olokola LNG project, a 6.3 mtpa liquefaction plant on the southwest coast of Nigeria that’s slated to come onstream in 2012.Three to four years ago, BG also inked a number of long-term supply deals with Nigerian LNG for up to 6.25 mtpa of LNG, supplies
- An ownership stake in Atlantic LNG’s four liquefaction trains in Trinidad & Tobago. Three of these trains are fully integrated operations for BG that include production and liquefaction of natural gas as well as the export of the subsequent LNG.
- A 22-year agreement, signed in 2001, to utilize 100 percent of the capacity at the Lake Charles re-gasification terminal on the US Gulf Coast, securing access to the world’s most liquid gas market. This agreement ensures that any uncontracted LNG volumes that can’t be placed with its international customer base at least can be sold into the US market at prevailing prices.
- A 40 percent stake in GNL Quintero, which owns the 2.5 mtpa LNG import facility on Quintero Bay, Chile. BG has a 21-year agreement to supply 1.7 mtpa of LNG from its portfolio. At peak capacity, the terminal will be able to supply about 40 percent of Chile’s current demand for natural gas.
How do these disparate assets work within BG’s business model? The company’s diversified supply portfolio includes volumes from its equity interests in liquefaction terminals in Egypt and Trinidad & Tobago as well as LNG purchased from third-party producers. (Thus far, the civil unrest in Egypt hasn’t disrupted BG’s natural gas operations. Accounting for 35 percent of Egypt’s natural gas industry, BG is integral to the country’s energy economy; regardless of the political outcome in Egypt, the company’s assets are unlikely to be at risk.) In 2010 12.7 mtpa of the company’s LNG supply was sold under long-term contracts.
BG’s LNG trading and shipping divisions work together to market, sell and deliver LNG volumes to customers worldwide on both a short- and long-term basis. In addition to marketing its own contracted LNG, the firm also buys volumes on regional spot markets and resells this gas to take advantage of regional pricing discrepancies.
Thus far, BG has sold LNG volumes to 40 countries, including inaugural deliveries to Canada, Chile, the Dominican Republic, Kuwait and Portugal in 2009-10. BG has also purchased LNG from 11 of the 18 producing countries. The map below demonstrates the scope of the company’s LNG trading operations.
Source: BG Group
To support these trading activities, the company’s shipping arm boasts a fleet of owned and contracted ships. Last year, the company added four carriers capable of transporting up to 170,000 cubic meters of LNG.
Over the long term, BG’s extensive global operations should enable the firm to benefit from a global LNG market where demand growth outstrips constrained supply. As we mentioned earlier in today’s issue, European markets upped their imports in 2010. Nations such as Spain, Belgium and the UK absorbed much of the LNG supply overhang that persisted after the global recession weakened demand and the ongoing shale gas revolution transformed the US market into an outlet of last resort.
LNG figures to become an increasingly important part of the Continent’s energy mix. Supply constraints, the planned decommissioning of nuclear reactors in Germany and a desire to limit reliance on Russian natural gas should prompt EU nations to build out the necessary cross-border pipeline and support infrastructure.
But the Asia-Pacific region–where long-term, oil-indexed contracts are the norm–represents the most exciting growth opportunity for BG. Management underscored this point during its Feb. 8 conference call to discuss the company’s 2010 results and outlook, noting that the use of oil for heating purposes provides ample opportunity for fuel substitution. High economic growth in Asian emerging markets should continue to drive robust demand among industrial, commercial and residential consumer segments.
Natural gas currently accounts for only 4 percent of China’s energy mix, but BG estimates that an increase of 1 percent in gas penetration adds 25 billion cubic meters per year to Chinese gas demand. That’s equivalent to the total output from four liquefaction trains at BG’s massive Queensland Curtis LNG (QCLNG) Project in Australia. Management also noted that if gas penetration in China were to approach the levels in India–still low by global standards–Chinese gas demand would increase by roughly 150 billion cubic meters per year, or about 1.5 times Qatar’s LNG production capacity. For those wondering about this seemingly obscure comparison, Qatar is the world’s leading producer of LNG.
Although the US experience and a lack of historical precedent has prompted many analysts to err on the side of conservatism when forecasting Chinese LNG demand, Marin Houston, BG’s Executive Director and Executive Vice President and Managing Director of Americas & Global LNG, has a decidedly bold take on what the next 10 years will bring. During the company’s Feb. 8 conference call, Houston stated: “[F]orecasters generally underestimate Chinese demand by a significant margin.” BG expects Chinese LNG demand to increase at a compound annual growth rate of 10.3 percent over the next 10 years, largely based on the rapid growth in contracted volumes announced over the past three years.
Based on this forecast for Chinese LNG demand growth and the likelihood of new markets coming online, global demand will likely eclipse the current consensus projection of 350 mtpa in 2020. At present, only 280 mtpa of liquefaction facilities are in operation or have been sanctioned for construction. With its low-cost supply base and global operations, BG is well-positioned to benefit over the long term from a tightening LNG market.
The QCLNG project will be a big part of BG’s long-term growth story. In its first stage, the facilities will consist of two liquefaction trains that have a total capacity of 8.5 mtpa, though the site will be able to accommodate two additional trains. BG made its final investment decision on the project in October 2010 and has inked long-term supply contracts for roughly 10 mtpa of LNG. Management continues to evaluate the potential of adding a third train to meet demand. The company’s substantial coal-bed methane gas fields will supply the facility.
Cost overruns and delays are always a concern on projects of this scale, particularly with wage inflation in the Australian labor market. Yesterday, BG halted construction on a 540-kilometer pipeline connecting the gas field to the LNG facility because the project failed to meet certain environmental requirements. Management stated that this temporary setback won’t prevent the facility from producing its first LNG volumes in 2014.
Outside of Australia, BG is evaluating the potential to deploy floating liquefaction facilities to capitalize on the estimated 14 trillion cubic feet of natural gas resources discovered in the company’s concessions offshore Brazil. Management indicated that it expects to conclude this analysis at some point in 2011.
BG’s global LNG business will benefit in the short term from an uptick in Japanese demand, but the firm’s efforts to increase its exposure to oil-indexed, Asia-Pacific markets should pay off over the long haul. Management forecasts that once QCLNG comes online, 75 percent of the firm’s LNG sales will be based on oil prices.
E&P
BG’s E&P division includes operations in the UK and Norwegian portions of the North Sea as well as stakes in emerging plays offshore Thailand, India, China and Tanzania. But the crown jewel of the company’s E&P operations are its interests in six blocks offshore Brazil, in the highly prospective Santos Basin.
Source: BG Group
The consortia involved in these blocks have moved quickly from discovery to commercial production. Only four years after discovering the massive Tupi, BG and its partners, Wildcatters Portfolio holding Petrobras (NYSE: PBR A) and Galp Energia (Portfugal: GALP), deployed the first floating production, storage and offloading (FPSO) unit in the field. Capable of producing up to 100,000 barrels of oil per day, this inaugural FPSO will be joined in the Santos Basin by 12 additional units over the coming years. In 2013 Tupi will receive its second FPSO and Guara will receive its first. The following year will bring a second FPSO to Guara and a single FPSO to Cernambi. From 2015 to 2017, BG and its partners will deploy eight additional FPSOs across Tupi, Cernambi, Iara and Carioca. Management estimates that over the next seven years BG’s annual Brazilian production capacity will expand by roughly 300,000 barrels of oil equivalent per day.
Expanding production, coupled with resource upgrades and new discoveries offshore Brazil, should provide plenty of catalysts for BG’s shares over the next few years. In the near term, drilling activity offshore China and Tanzania could provide further upside.
T&D
Without delving into too much detail, BG’s transmission and distribution operations are concentrated in Brazil and India, two emerging markets where demand for natural gas-fired power plants will continue to grow as their economies expand.
With a number of near-term catalysts likely to buoy the stock and exposure to attractive long-term growth trends, BG Group–a new addition to the Wildcatters Portfolio–rates a buy under GBp1,650 on the London Stock Exchange or USD133 in the over-the-counter market.
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