Natural gas extracted from two miles under the earth in West Texas is helping power homes in Pakistan. Large-scale liquefied natural gas (“LNG”) liquefaction companies, like Cheniere Energy, are on the forefront of making this would-be dream a reality. The global energy sector is more inter-connected than ever before, and natural gas has come to the forefront as a relatively clean “bridge” fuel . While this has helped reduce the cost of energy worldwide, the global focus on combating climate change and the regulatory changes to address climate change pose a real threat to energy infrastructure project developers like Cheniere Energy.
In a simplistic sense, LNG liquefaction companies compress and liquefy natural gas, which is then exported to energy-starved markets globally. Like most energy infrastructure projects, LNG liquefaction projects require a large upfront investment to the tune of $10 – $30 billion and take roughly 7-10 years from initial inception to commercial reality . In the energy world, this time-frame is equivalent to ions of years and a lot can change in the marketplace between when projects are incepted and when they become a commercial reality.
To mitigate the extended time horizon and changing market landscape, large scale LNG projects have long-term, fixed-priced, take-or-pay off-take contracts in place with credit-worthy counterparties before they begin spending the big dollars on the construction of the projects. However, these contracts are usually for roughly 80% of the project’s overall capacity and for about 15-20 years – the combination of which is expected to generate a modest return on the capital invested in the project.
But a significant portion of the value for companies like Cheniere Energy is expected to come from the ability to sell the uncontracted volumes at attractive margins in the near-term and re-contracting with customers beyond the initial contract period in the long-term. This is where the rubber meets the road.
While near-term demand in energy-starved markets has and will fluctuate from season to season, longer-term demand prospects seem glim, or rather lower than expected as compared to that at the time of project inception. This is mainly due to the importance placed on renewable energy sources by the regulatory regimes in most demand-pull markets such as India. The reason for this is two-fold:
- Actions to meet goals related to renewable energy standards – Most countries that have been forecasted to increase their dependence on natural gas have instead chosen to invest, or rather, subsidize renewable energy investments 
- Although natural gas via LNG might be cheaper as a delivered ex ship (“DES”) commodity today, significant infrastructure investment is needed in terms of pipelines, power plants and transmission channels to convert that into tangible electricity in power, especially across a large geography.
To address these challenges in the short-term and the long-term, Cheniere’s management is taking a few key steps:
- Short-term – For its excess uncontracted merchant / spot volumes, Cheniere is looking to enter into short-term contracts with credit-worthy counterparties to mitigate seasonal and annual demand fluctuations due to weather. An example of this being their deal with Engie in Europe 
- Long-term – In demand-pull markets lacking infrastructure as it relates to regasification of LNG or power plants, Cheniere is teaming up with local developers and investing in such infrastructure projects to ensure a sustainable market for its LNG in the long-term. A classic example of this being the Andes project in Chile .
Given the contractual nature of the business, the short-term prospects of the business are fairly certain and measurable. However, in addition to the measure taken by management to address potential threats, I would recommend the following strategic actions to ensure the business is viable in the long-run.
- For the newer development projects, the key would be to focus on smaller-scale, more modular LNG projects. While it would be slightly more expensive on a per unit of energy metric given lower fixed cost synergies, it would help Cheniere better cater to changing market needs and demands .
- Developing floating LNG projects will also be key in the long-run. Given the uncertain regulatory climate both in the US and abroad, floating LNG projects will help mitigate binary regulatory risk and help Cheniere be nimbler in an ever-changing global market.
Key fundamental questions do arise about the industry and the company. Given the enormous upfront capital investment and the long lag time to bring these projects to fruition, trust in the US regulatory regime to export natural gas to both FTA and non-FTA countries has been a fundamental tenant and value driver of this business. Can this trust last forever? In addition, with most nations doubling down on renewable energy with subsidies, how much longer will natural gas be the bridge fuel of choice?
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(6) Naureen Malik, “Chile Just Gave Cheniere a Big Reason to Build Another LNG Plant”, https://www.bloomberg.com/news/articles/2016-06-30/chile-just-gave-cheniere-a-big-reason-to-build-another-lng-plant, accessed November 2017
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