Description

I am recommending a long position in LNG Limited (LNG AU). The Company has made substantial progress de-risking two North America LNG export facilities with a combined 20 mtpa of capacity, Magnolia LNG (U.S. Gulf of Mexico) and Bear Head LNG (Canada East Coast), with every 4 mtpa of fully developed export capacity worth approximately AUD 3.00 per share on a discounted basis at an 8% yield on free cash flow after principal amortization. At AUD 2.00 the stock is implying a very low probability of future success, and there should be significant appreciation in the shares over the next six to twelve months as projects are de-risked and the stock is listed in the U.S. Over time, successful development of all of its capacity could lead to a share price in excess of AUD 15.00.

LNG Limited (LNG AU) has an AUD 1.0B market capitalization ($820mm) with AUD 60mm of net cash, and ownership of two LNG export facilities currently under development, Magnolia LNG and Bear Head LNG.

Magnolia LNG

Magnolia LNG is a proposed 8.0 mtpa LNG export facility in Lake Charles, Louisiana. The Company has made substantial progress in all aspects of the development of Magnolia LNG and anticipates a final investment decision and start of construction in 3Q15, with LNG production by the end of 2018.

·       Regulatory approvals. Magnolia LNG must receive final approval from the Federal Energy Regulatory Commission (FERC) and Department of Energy (DOE) before construction can begin. The project is progressing through the process with FERC and should receive both a draft Environmental Impact Statement and a Notice of Schedule from the agency within the next 60 days. These documents will provide the Company and potential customers with certainty around timing and allow the DOE to begin its process to issue a non-FTA export license to the project. An exhaustive read-through of the regulatory filings for Magnolia LNG and engagements with consultants indicate that the project is progressing well with no potentially costly issues.

·        Project-level financing. LNG Limited has signed a definitive agreement with Stonepeak Partners, an infrastructure private equity firm with $1.2B of assets under management, to provide all of the equity for Phase I (4.0 mtpa) of the Magnolia LNG project. LNG Limited receives “free carry” in exchange for giving Stonepeak approximately 45% of the cash flow from the project and is only responsible for contributing capital in the event of cost overruns, unlikely in a lump sum turn-key EPC contract. LNG Limited has also selected BNP Paribas as its project debt advisor and has begun reaching out to lenders to provide debt financing for Magnolia LNG. The recent financing by Cheniere Energy (LNG) for its Corpus Christi LNG facility ($11.5B) shows that the market for LNG projects is still very much open despite the recent decline the price of oil.

·      Lump sum turn-key EPC agreement. SK E&C, the E&C division of SK Group, the third largest South Korean conglomerate, has been selected as the EPC provider for the Magnolia LNG project. SK E&C recently provided LNG Limited with a lump sum turn-key EPC contract price of $2.0B for Phase I of the project and an estimate for Phase II of approximately $1.0B, consistent with guidance provided by management and the 55% ownership split to LNG Limited. The LNG Limited proprietary Optimized Single Mixed Refrigerant technology, a variant on single mixed refrigerant technologies in use globally, allows the entire project to be built at a below-average capital cost of $440 per ton. Diligence conducted with competitors and EPC companies, and a review of the cost projections of other proposed mid-scale projects and the suppliers the Company will use for the facility validate the cost estimate.

·      Long-term LNG offtake agreements. Magnolia LNG has signed letters of intent with four parties representing 7.0 mtpa of the total 8.0 mtpa capacity of the project, Gas Natural (GAS SM), AES, LNG Holdings (private), and Gunvor Group (private). While a letter of intent is not a binding agreement, it does suggest that LNGL is making substantial progress with potential customers for Magnolia LNG and the presence of Gas Natural, a very high-quality customer (large Spanish utility with a global LNG portfolio, also a customer of the Sabine Pass and Corpus Christi LNG projects), provides a great deal of credibility to the project. Management also recently indicated that at least two other potential counterparties are in advanced discussions with Magnolia LNG.

The Company should receive all regulatory permits, execute a binding lump sum turn-key EPC contract, sign long-term LNG offtake agreements, and complete project-level financing by the end of 3Q15. The market should give the Company credit for the 8.0 mtpa worth of capacity at that point, driving significant upside in the stock.

Bear Head LNG

Bear Head LNG is a proposed 12.0 mtpa LNG export facility in Nova Scotia, Canada, with LNG production expected to begin in 2019. The Company acquired the facility from Anadarko Petroleum (APC) earlier this year and has already made substantial progress in the development of the project. LNG Limited owns 100% of the project and a successful de-risking of Magnolia LNG should allow the Company to finance the project through an equity raise at a higher stock price or project-level equity. Unlike in the U.S., the regulatory environment for LNG exports in Canada is very favorable and the Company has already filed its application for an export license with the National Energy Board (projects are approved with such regularity that potential customers view the filing of the license application as enough to begin to sign contracts with a facility). Also, the pipeline and natural gas supply network in Nova Scotia is much less developed than in the U.S. As a result, potential long-term contract counterparties must also provide natural gas supply. Given its proximity to the Marcellus Shale in the U.S. (Bear Head LNG recently filed with the DOE to export natural gas to Canada for liquefaction) and natural gas reserves offshore (the Deep Panuke and Sable Island fields and recent activity offshore by BP, Hess, and Shell), two sources of natural gas with significant reserves that would see a tremendous uplift in pricing if the natural gas were to be converted to LNG and exported on the global market, the facility should not have difficulty obtaining long-term contracts. The Company does not need to receive any credit for Bear Head LNG to see substantial upside in the stock, but management is moving rapidly to develop the project and expects to receive regulatory approvals and begin to sign binding contracts by the middle of 2015.

The Company also owns 100% of the proposed 3.8 mtpa Fisherman’s Landing LNG project in Queensland, Australia, but I attribute no value to this property as the site has had difficulty obtaining long-term natural gas supply agreements to fuel the facility. 

Risks

·         Commodity price changes lead to lower demand for long-term LNG offtake agreements. The decline in the price of oil is the largest contributor to the decline in the stock since September as LNG prices in Asia tend to be indexed to the price of oil and a lower LNG price reduces the arbitrage profit available when exporting LNG from the U.S. Magnolia LNG will still be able to obtain long-term contracts because: 1) customers have signed 7.0 mtpa worth of LOIs and are in late-stage discussions with Magnolia LNG with specific projects in mind for the LNG (e.g., a natural gas plant in Latin America that needs fuel) and do not plan to take LNG to Asia (Latin America is the destination of choice and the arbitrage is open there, even at current prices), 2) customers are making a decision with a twenty-year view beginning five years from now when the Brent oil futures curve is roughly $75 per barrel and LNG exports from the U.S. “work” to all regions of the world, 3) customers value diversity of LNG supply and flexibility to not take a cargo (and still pay the fixed liquefaction fee) should their plans change, and 4) the U.S. is a low-cost provider of LNG relative to other proposed projects in Western Canada and Africa, so other projects will be cancelled, potentially increasing demand for LNG from the U.S.

·      Process technology does not work as intended or EPC contractor is unable to complete construction. A detailed analysis of both the technology and SK E&C, including a review of technical literature provided by both LNG Limited and EPC providers, comparable projects, and the track record of SK E&C in LNG and other similar projects, and conversations with competitors and EPC providers, shows that these risks are well contained.

·        Capital markets do not permit the issuance of new debt to fund construction. This risk is modest in light of recent project-debt financings completed by Corpus Christi LNG and Freeport LNG at attractive interest rates of L + 200-225.

Catalyst

Regulatory approvals.