Energy's Liquid Future

This is a golden age for oil and energy investments. Either that, or a fiery sunset that ends with oil and resource wars. But, Dan Denning prefers to look on the bright side, where liquid natural gas plays a prominent role in our future…

In late 2004, The Japan Times reported that Beijing gave several Chinese companies permission to conduct natural gas exploration in the East China Sea, an area the Japanese have long considered an exclusive economic zone. The Chinese also put pressure on Russian president Vladimir Putin in October to proceed with an $18 billion, 3,000-mile gas pipeline project from Russia’s Kovykta Field in eastern Siberia to China’s refiners to the south.

The Chinese also pushed on a 1,500-mile link from western Siberia. Japan, meanwhile, is pushing for a pipeline from Vladivostok over the Sea of Japan. Unmentioned was the big prize, the 18 trillion cubic feet of natural gas reserves that sit off the shore of Russia’s Sakhalin Island. The island was a brutal and remote prison during the reign of Czar Alexander II. In fact, Russian poet and writer Anton Chekhov visited the island in 1890.

After his visit, he wrote in a letter, "God’s world is good. It is only we who are bad…One must work, and to hell with everything else. The important thing is that we must be just and all the rest will come as matter of course…"

The rest is coming to Sakhalin Island now, just God or no. The island is the energy mother lode of the region – a find rivaling Alaska’s North Slope – and the kind of resource, if properly harnessed, that could power the region’s energy needs for decades. It matters a great deal because the countries of northeast Asia are already vulnerable to disruptions in the flow of oil from the Persian Gulf.

China, South Korea, and Japan are already some of the world’s largest oil importers. It’s a precious energy lifeline that could easily be cut, either at the Strait of Hormuz or at another chokepoint, the Strait of Malacca.

Liquid Natural Gas Opportunities: A Golden Age

How will a country like South Korea keep its powerhouse export driven economy going without getting sucker punched by high oil prices? The answer is unknown. But continued development of its energy infrastructure – with companies like KEPCO – will help. Another answer may lie in liquid natural gas (LNG).

This is a golden age for oil and energy investments. Either that, or a fiery sunset that ends with oil and resource wars. But I prefer to look on the bright side. At the moment, however, the bright side of the oil and gas market is dimly lit. Continuous supply disruptions – whether by acts of terrorists or acts of God have altered traditional relationships between supply and demand, while also obliterating America’s long-standing complacency about oil and gas supplies. Uncertainty reigns.

But amid the uncertain conditions of our changing petro-political world, liquid natural gas will certainly assume a prominent role. As I see it, there are two major opportunities in LNG: terminal construction and tanker construction. With LNG demand likely to rise from 120 million tonnes in 2003 to 200 million tonnes by 2010, and then 315 million tonnes by 2020 (according to estimates from the International Energy Agency), it’s a question of getting the right mix of investments. But first a little background on the LNG market. The excellent Plunkett’s Energy Industry Almanac for 2005 offers the following insights:

"One development as a result of higher [energy] price levels and increased demand is serious interest in supplying America’s gas needs through LNG (liquefied natural gas). However, due to the necessity of special handling, bringing that supply online in a major quantity will take huge capital outlays and require considerable time. LNG requires special processing and transportation. First, the natural gas must be chilled to minus 260 degrees Fahrenheit, in order for it to change into a liquid state. Next, the LNG is put on specially designed ships where extensive insulation and refrigeration maintain the cold temperature. Finally, it is offloaded at special receiving facilities where it is converted into a state suitable for distribution via pipelines."

Specially designed ships indeed! According to LNG Shipping Solutions, there were only 151 LNG tankers in operation in October 2003. And no wonder. Because of the rigorous specifications, the average cost of a 138,000-cubic-meter LNG tanker is about $160 million. According to the Energy Information Agency, that’s more than double the price of a crude oil tanker that could carry four or five times as much energy.

Yet despite the cost and the seemingly bad comparison to oil tanker economics, there were 55 LNG tankers under construction as of last year. Forty-six of them are designed to carry 138,000 cubicmeters of LNG, which translates into about 2.9 billion cubic feet of natural gas. LNG Shipping Solutions also notes that the ships currently under construction would raise the total fleet capacity by 44 percent, or from 17.4 million cubic feet of LNG (366 BcF of natural gas) to 25.1 million cubic meters of liquid (527 BcF of natural gas).

Liquid Natural Gas Opportunities: Demand Will Keep Rising

But even with the increased capacity, Plunkett’s says demand will keep rising enough to make looking at LNG-related investments worthwhile. Plunkett’s continues:

"An analysis conducted in late 2003 by the National Petroleum Council projected that the U.S. could meet as much as 14% of its natural gas needs through LNG imports by 2025, if sufficient infrastructure were built, including seven new LNG transportation facilities. Transporting LNG from distant countries presents massive technological and financial challenges, but importing LNG from those nations could provide much needed gas for the U.S., assuming America is willing to add to its already bloated import bills and balance of payment problems. One of the biggest barriers to wider use of LNG in the United States is a lack of terminals to receive it."

California is already witnessing a fight between those who see the benefits of cheap natural gas and those who don’t want LNG terminals built offshore. But let’s assume for a moment the cheap energy interests will win out over the NIMBY interests. Who will make all these new LNG terminals? And who will make the ships to transport the LNG from the rich gas fields of the world to the hungry energy markets of Asia and America? First, Plunkett’s conclusion:

"The LNG business is already booming. Growth will continue as oil companies and oil-rich countries realize the benefit of transporting gas in liquid form. LNG technology is moving ahead rapidly, and costs for transporting it are coming down. Shipping and handling will become more competitive as more ships and facilities come into operation, and large quantities of LNG on the market could stabilize or even depress natural gas prices.

"Many markets outside the U.S. are also prime targets for LNG imports, including China and India. Japan is already a huge importer of LNG, there being little other way to transport gas to the island country…the United States contains vast quantities of natural gas in areas that currently cannot be exploited. The U.S. Geological Survey estimates that there are 1,400 trillion cubic feet of recoverable natural gas in the U.S., which would be enough to power the nation for decades.Most of this gas lies beneath regulated federal and state lands (particularly in Rocky Mountain basins, offshore America’s east and west coasts and offshore the west coast of Florida), much of which cannot be drilled upon under present regulations.

"Environmental and regulatory concerns may mean that most of this gas will never be produced, unless economic imperatives intervene…For the mid-term, gas will remain in great demand, and prices will tend to be high. While there is significant additional gas to be found in the Gulf of Mexico, such projects take years to bring online. Meanwhile, the largest potential exporters of natural gas to the U.S. are those countries with the largest proven reserves: Russia, Iran, Qatar, Saudi Arabia, Algeria, Venezuela, Nigeria, Iraq and Indonesia, in that order."

Liquid Natural Gas Opportunities: South Korea

If you take a look at Plunkett’s list of countries, and if you’re anything like me, you’re probably pretty uncomfortable making investments in Qatar, Saudi Arabia, Venezuela, Nigeria, and Iraq. But the good news is, you don’t have to.

With major oil and gas companies just beginning to develop LNG terminals and gas fields all over the world, the place to look at future investment opportunities is in the LNG shipping business. That brings us directly to South Korea, which has the good fortune of being in the heart of one of the most energy ravenous regions of the world. It also has some of the most successful LNG ship makers in the world.

Building LNG ships is complicated. For example, if you poured liquefied gas into a steel tank, it would shatter like glass. LNG ships are made of the kind of materials that can keep the gas cool once it’s been liquefied, which involves thick aluminum, nickel steel, and balsa wood (for insulation). It’s an art the South Koreans have perfected. And you can expect the South Korean shipbuilders to profit handsomely.

As the petro-political map of the world evolves, we’ll be keeping a close eye on LNG. But the entire energy complex is in a strong bull market. Another way to invest is to go long some of those oil- and energy-related ETFs and index funds we discussed earlier. It wouldn’t surprise me a bit if you can soon buy a crude oil or natural gas ETF the same way you can now buy gold.


Dan Denning
for The Daily Reckoning

July 13, 2005

Dan Denning, editor of Strategic Investments, is one of America’s most respected "big picture" analysts working today. The above essay was adapted from his new book, The Bull Hunter.

In The Bull Hunter, Dan lays out all the details of how to profit in ways most investors never imagined just five years ago. What’s more, he’ll show you why it’s never been more dangerous to put all your investment eggs in the basket of the U.S. economy. It’s a timely warning, along with an exceptional opportunity.

London is back to normal. It is a beautiful sunny day. The bombings seem almost forgotten.

"Are you kidding?" said a colleague, "They were forgotten the next day. People were back on the tube [the subway] complaining about how slow the trains were."

In the War on Terror, Britain seems to have taken its skirmish in stride. But, as expected, the imperial power panicked.

America ordered its soldiers in Britain to stay clear of London, as the city was "too dangerous." But even if there were similar bombings every week, a young man would still have less chance of dying suddenly and unexpectedly in London than he would in Washington, DC.

America needs to panic; the empire needs an enemy.

We have been thinking about the difference between value and price. Panics move prices; values stay the same. Buyers panic thinking they might miss an opportunity. Sellers panic when they are afraid they might get stuck in a losing position. Prices can fluctuate wildly. One day investors consider a dollar’s worth of corporate earnings worth $10…a few weeks later, the same dollar might be priced at $30. Go figure. There is no particular reason for buyers or sellers to believe one thing one day and another the next. But things happen – sometimes incredibly absurd things – and people come to believe what they need to believe in order to play their roles.

America now needs to "buy" into the great terror war. And it needs to get the rest of the world to "buy," too. Otherwise, its position as imperial guardian of the world’s peace and order is called into question. Americans might begin to wonder why they pay for military bases in Kyrgistan and Khazakstan and other stans all over the globe. Kyrgistan and Khazakstan might wonder what they need protection from. But there are still a few sad teenagers willing to detonate themselves…and so terrorism’s stock rises. Italy is considering new "antiterror legislation," says the International Herald Tribune. The European Union is taking up other measures. America itself is tightening the noose around its own citizens’ necks – with more and more controls, prohibitions, crimes and punishments. A man cannot walk down the street or blow up a post office without an army of tattle-tales and cops coming after him.

Many Americans have come to believe what they need to believe – that terrorism is the greatest threat to ever face the civilized world, despite the fact that the terrorists seem incapable of mounting more than one serious attack every year or two, with results that are (in the grand scheme of things) inconsequential. And when they carry out their attacks, the terrorists eliminate themselves; which hardly seems a serious way to bring down a great empire. Terrorism, in our opinion, is overbought.

Our beat, here at The Daily Reckoning, is money. But money, in itself, does not interest us. Instead, what fascinates and amuses us is the gap between price and value – a gap that is filled with illusions, vanities, frauds and humbugs. We find these not only entertaining, but also profitable. The greater the illusions…the further back towards the mean things can regress.

The further things have gotten out of whack, the more money to be made when they go back where they belong.

The bombings in London were done by a group of young men – from Yorkshire.

"It was so odd," continued our colleague. "We listened to a brother of one of them on the radio. You know, they are Muslim; their parents came from Pakistan. But they were born here. And the brother spoke with a Yorkshire accent. I would never have expected a Yorkshireman to want to bomb the London tube."

At the beginning of the last century, Europe and America suffered a similar spree of terrorism. Then, the terrorists were called "anarchists" – scruffy intellectuals with a grudge against Western civilization and its less civilized American cousin. Then, as now, politicians fulminated. The newspapers ranted. The gendarmes, polizei and Bobbies rounded up the windy anarchists, hauled them before the courts, and sent them to prison – when they could catch them.

And while thus engaged in making the world safe from "anarchists," WWI began. Within hours, the anarchists were forgotten.

More news, from our team at The Rude Awakening:


James Boric, reporting from Indiana…

"Making money in the small-cap market is like finding a woman; you just have to know the right places to look."


Bill Bonner, with more views:

*** More worries over the CNOOC bid for Unocal. Our good friend, Chris Mayer, sends us this note:

"The Unocal and CNOOC and Chevron drama is playing out right before our eyes. A partially government-owned Chinese oil company and American oil giant in a bidding war over Unocal. The international stage just got a little more crowded, as Chinese enterprises are looking to expand overseas. Investors won’t want to overlook the investment implications of a new global power."

And who would have guessed this? A congressional hearing into the national security repercussions of the bid began in Washington today with a flood of strong rhetoric against the Chinese company.

"A successful CNOOC bid would increase China’s leverage over U.S. interests in Asia," warned the chairman of the House Armed Services Committee. He also blasted Chinese companies for not behaving as "normal commercial entities" on the international market.

The Unocal bid would be the largest foreign takeover ever completed by a Chinese firm. Now, the world improvers in Washington are doing their best to see that it doesn’t go through. The guvmint’s Committee on Foreign Investments – the band of do-gooders who review offers for American companies by foreign entities – has even declined to begin a review of CNOOC’s offer for Unocal…possibly delaying any deal between the two.

*** Bernie Ebbers popped up in the news again today. We had almost forgotten about him – the WorldCom CEO who claimed he didn’t know anything about running a business, so he couldn’t be held accountable for an $11 billion accounting fraud.

He was sentenced to 25 years in federal prison…which could effectively be the rest of his life, as the ex-CEO is now 63.

Just as we always say, dear reader, people get, not what they expect, but what they’ve got coming.

*** The euro is still recovering. It moved up to $1.22 yesterday. Bad news for tourists. "But it’s not the euro that is growing stronger," says our London correspondent, Adrian Ash today. "It’s the mighty dollar that is showing weakness once again.

"The British pound sterling has also turned versus the greenback. It stayed at EUR1.45 to the euro on Tuesday, but rose two cents to $1.77 against the dollar. Indeed, the USD has begun sliding against pretty much everything – Czech koruna, Mexican pesos, Hong Kong dollars…"

"Yesterday’s drop in the dollar helped put gold back below EUR350 for French and German investors. It fell beneath our buying target for British investors, too – the first such dip in three weeks. An ounce of gold now sells for 30 pence less than £240 an ounce, its ceiling of the last 10 years. American investors with any pounds left in their wallets from their last visit to London might want to swap them for gold."

*** The Brazilian real has appreciated against the dollar by 11%. Hey wait a minute…we thought the Brazilians were incapable of monetary discipline. We thought they practically invented ‘funny money’. We thought their economy was a basket case.

Well, weren’t we wrong? The Central Bank of Brazil is tight – with an overnight lending rate of 19.75%. It is the bank of Alan Greenspan that is loose – with an overnight lending rate still below inflation. Well, what is the inflation rate in Brazil, you may wonder? A-ha…in the 1990s, Brazil saw prices rise at a rate of 7,000% a year. Now, the rate is near 5%, with a target of 4.5% next year.

The virtues that pay are neither eternal, national, nor geographical. Instead, they are cyclical everywhere. Prudence, sweat, thrift, and discipline once paid off north of the Rio Grande. Now they pay off in Rio itself.