The Changing Nature of Global Gas Projects
It’s 4 a.m. in Moscow, and my flight back to the U.S. leaves in a few hours.
One thing is certain about my trips to Russia – the time schedule is always off.
But I can’t complain; this week-long visit has provided many benefits.
Last Friday I told you the primary purpose of my trip was to evaluate natural gas projects in northern Russia. As I said, it’s becoming increasingly necessary to estimate global-wide gas prospects in order to determine effective price levels.
That’s because the age of “spot” market prices in the gas sector is rapidly approaching.
And it’s about to change the way the markets operate for everyone involved.
On the Spot
Spot markets allow for a very short-term exchange of volume (usually 72 hours) and serve to undergird longer-term contract pricing.
They tend to offset these longer contract terms by providing volume at what is usually a discount to the contracts, which are more properly futures contracts on the energy commodity.
However, natural gas has not had featured spot sales except in those areas that serve as major centers for pipeline interchange. Those would then serve as provisional benchmarks for wider markets.
Unlike crude oil, which can be moved by tankers to virtually anywhere there is a decent port, thereby allowing for the establishment of local spot markets, gas has been limited by how far pipelines extend.
But the acceleration of liquefied natural gas (LNG) trade – in which gas is cooled to a liquid state, transported by tanker, and then regasified on the other end – has altered the picture.
Indeed, with more than 90 new terminals set to open, under construction, or in the final stages of approval worldwide, LNG is one of the most decisive changes to hit the energy sector in decades.
LNG imports are essential to meet the energy needs in many parts of the world where little exists in the way of domestic sources. The export of LNG also provides a new outlet in those regions where new unconventional gas volume is straining local demand and threatening adequate price levels for producers.
This latter consideration affects all major shale gas production basins in North America, from the Horn River and Montney in Western Canada to the Marcellus, Barnett, and Fayetteville in the U.S.
And, as I have noted on several occasions, the rise of LNG trade can serve as a major excess production drain off for the U.S.
What LNG does not do, however, is address a concern arising in several places in the world.
See, it is one thing to provide an end market for additional production…
It is quite another to integrate the production assets into the equation.
Let me explain.
Reassessing Asset Values
If LNG trade – involving gas production in one country and usage in another – benefits the volume of gas involved, it does nothing to provide for pricing the land assets where production takes place.
Unlike crude oil, which is now mostly produced in countries serving as exporters and having little overall domestic demand for the product (Russia being a major exception), gas remains primarily a domestically utilized energy. That means the primary market served remains a local one.
However, should international demand become the primary determinant of gas prices, the value of productive acreage would likely become dependent on the LNG trading price.
Yet relying on LNG to determine the price (of both commodity and field) would be an energy-sector equivalent of the tail wagging the dog.
Given that the rapid rise of global gas trade is now a certainty, there needs to be a way to balance local, national, and international gas prices with the underlying value of the land where production takes place.
Which brings me back to the other reason I traveled to Russia.
The Financing Gap
As the costs of major gas projects increase, especially in locations like the Arctic, new funding prospects are required.
As I’ve told you, Moscow will not allow foreign majors to control these new mega projects, so there are few established ways of obtaining the huge amount of funding required.
My suggestion is to use assets in one basin to collateralize financing projects in another country.
That would allow the value of acreage that is, or could be, used for gas production in, say the U.S., to be tied to the value of production in Russia (for conventional gas) or Poland (for shale gas).
Extractions elsewhere serve to buttress the overall value of assets in the U.S., while the American assets both serve as a financial base for projects abroad and participate in the revenue flow of foreign production.
The suggestion likewise provides for cross-finance of U.S. projects from proceeds generated elsewhere, as well as the development of genuine holdings not requiring that one market wins while another loses.
In short, this overcomes competition by providing a win-win scenario to replace the zero-sum game usually played (somebody’s production undercuts the market access of somebody else).
We end up creating a genuine global view of production without discounting the value of anyone’s fields… anywhere.
And What of the Individual Retail Investor?
Well, we certainly have been talking a lot about Master Limited Partnerships (MLPs) in the U.S. gas industry. Remember, these are the holdings that control production or more often midstream services (pipeline, storage, gathering, and initial processing).
By law, MLPs pass all profits to partners, thereby allowing the holding to avoid corporate taxes. All tax liability on all profits rests with the individual partners.
When an MLP chooses to do a public offering, the shares that make up that offering participate in the flow-through profits via dividends that are considerably better than market averages.
In that way, average investors are able to participate without becoming partners in the MLP itself.
I have suggested the same approach for what I have in mind. Placing a portion of these European/Russian/U.S. cross-holdings, representing gas deposits in various countries as accessible public offering provides three advantages. And there are three main benefits.
- It raises additional funding for gas projects using existing acreage and/or production as collateral;
- It provides predictability for the local impact of variations in field value;
- And it expands participation to average investors worldwide.
The first of these IPOs will probably emerge in Frankfurt (which is why I was there two weeks ago). The prompt issuances of depositary receipts will make them accessible in major markets throughout the world.
Sometimes the way to offset commodity warfare and the “either-you-win-or-I-do” view is to give each participant a vested stake in the idea of working together.
I’ll let you know how it works out.