Opening the Mailbag: LNG, IMO 2020, and Oil Prices
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Opening the Mailbag: LNG, IMO 2020, and Oil Prices

by | published July 31st, 2019

A service like Oil & Energy Investor by its very nature invites questions of all sorts pertaining both to energy and geopolitics.

I have been quite fortunate to hear from many of my readers both in person at conferences and chance meetings and in online comments on the website and on social media.

This is exactly what this service is all about – to inform and advise as to where the markets are going in the sectors in which I am directly involved. I truly enjoy hearing your questions, and they allow me to know what kind of information you’re interested in from me.

With that said, it has been quite a while since I answered some of the questions you have sent along,


So today, let’s take a look at three questions from my readers…

Darrell W. asks, “What are your thoughts on Cheniere LNG?”

Well Darrell, Cheniere Energy (LNG) has been on my radar for years, and it has provided impressive returns on several occasions in my other services. However, the situation has been changing in three important ways, even as prospects for companies best positioned improve.

First off, liquefied natural gas (LNG) is likely to be the fastest growing segment of the energy sector for the next decade. Cheniere has been in the LNG business of exports longer than anyone (which explains how the company grabbed that prized ticker symbol).

In fact, when I knew the company founders almost twenty years ago, they were expecting to import LNG into the U.S. Actually, before the immense reserves of shale and tight gas were realized, we all thought the country would be importing more LNG from abroad.

Second, Cheniere pioneered an integrated “modular” financing model. This involved securing multi-billion-dollar twenty-year agreements with some of the largest LNG importers globally and then using the contracts to secure financing for a section of the Sabine Pass production and export facility on the Texas-Louisiana Gulf coast. As such, production was secured and trade guaranteed.

But most of that occurred in a different environment. Cheniere has the advantage of a fully developed production and export cycle, while also benefitting from low costs for domestic natural gas feeder stock. On the other hand, a persistent low price for that gas is likely to begin cutting into the raw material flow as field production is scaled back.

Third, the company has managed to increase exports and run a profit despite the declining price of LNG in the international market, indicating that being first to set up operations and having the foresight to secure big contracts early on remain important.

Cheniere can parlay sales to European and Asian end users, the latter thanks to the widening and deepening of the Panama Canal now allowing direct transit from Gulf Coast U.S. to the Pacific. That means it has a better position in the market than competitors. That market will see additional LNG consignments and more of that will be accounted for by American exports.

If you’d like to learn more about Cheniere – along with other profit recommendations in the Energy Advantage Model Portfolio – just click here and you can get access to everything.

Next, William J, queries: “Will production help or hurt the price of oil in the near future (one to two years) as production rises from 12 million barrels a day to 17 million barrels?”

This question addresses whether the U.S. market can sustain continuing rises in aggregate production in the face of concerns over whether demand will rise to meet it. Well, the production market will be pretty much self-regulating in this regard.

As we once again approach $60 a barrel for WTI (West Texas Intermediate, the benchmark crude rate set in Cushing, Oklahoma, for New York futures contracts), most American operating companies can run at a profit. There is no need to flood the market in a desperate attempt to stay one step ahead of the sheriff, as was the case in 2015-16 when prices were collapsing to below $30 a barrel.

There is now enough extractable reserves to hit 16 million to 17 million barrels day in overall production but there is no reason why it would go that high. Leaving known volume in the ground is a collateralization of forward production value and makes more sense.

In the current environment, any company that must move high levels of extraction downstream to survive will not be around long anyway.

Exports are a way of allowing additional domestic production without depressing the price at home. The U.S. is exporting about 3.5 million barrels on any given day. However, I estimate that the present effective ceiling tapers off just above that level (3.6 or 3.7 million). There is additional port and harbor capacity coming online as early as the first quarter of 2020, but that will have to service both crude oil and refined oil product export streams.

Realistically, forward domestic demand (i.e., what is needed by refineries) and a somewhat expanded export picture should allow for higher production levels. But anything north of 14 million barrels a day is probably not sustainable.

If we get to that point, another round of mergers, acquisitions, and bankruptcies will occur as efficiency of field operations combine with company debt levels to determine who remains – and gets bigger.

Finally, Duane W. poses this question: “How will the January 1 usage of sweet oil on tankers change the price of oil?”

In what has been one of the major changes in recent years, seagoing vessels will be switching to lower sulfur content (i.e., sweeter) fuel at the beginning of next year. The International Maritime Organization (IMO) is requiring that some 80% of ship sulfur emissions be cut worldwide in what is known as IMO 2020. This is the most dramatic change in fuel composition ever attempted in any transportation sector.

The specific cut requires the usage of lower sulfur-content fuels to enable the present maximum fuel oil sulfur limit of 3.5 weight percent (wt%) to move down to 0.5 wt%.

The transition will increase the cost of bunkering fuel throughout the world.

Shipping consumes about 3.9 million barrels of fuel oil daily, about half of all fuel oil consumed. Some of the increases in fuel costs already began appearing last month, six months before the IMO 2020 regulations are set to be enforced.

There are some other unexpected effects.

For example, there are other usages of low-sulfur fuels, such as the availability of needle coke used in metallurgy (the production and purification of metals), steel manufacturing, and even electric vehicle battery production. Some analysts have suggested the redirection of low sulfur fuels to marine use will increase the cost of producing such products.

Also, the increasing need for low sulfur fuel oil will also put a strain on the determination of refinery cuts. That means how much refining capacity is committed to each product in the low sulfur distillate sector – fuel oil, heating oil, and diesel – may end up with shortages in some of these categories.

Since all of this involves the availability and pricing of refined products, there will be little knock-on effect on the price of crude oil.

But the more interesting play is in identifying refineries that have the capacity (and efficiency) to increase processing of the IMO 2020 compliant fuel.

This is something I have covered in Energy Advantage, as one of the Portfolio’s biggest winners is an American refiner – one of the best in the industry. If you’d like to learn more about it, just click here.

Again, I very much value your questions and comments. If you have anything you’d like to add or query, please drop me a comment at the bottom of this column, right here.

Sincerely,


Kent

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