America’s escalating trade dispute with China has been weighing on sentiments across markets. On May 10, Washington raised tariffs on $200 billion worth of Chinese goods from 10% to 25%, while Beijing retaliated by imposing higher duties on a revised list of 5,140 U.S. goods worth $60 billion. Among others, China raised the tariff on imported liquefied natural gas (or LNG) to 25% from the prior level of 10%.
The deteriorating Sino-U.S. relationship in the form of several rounds of new tariffs (or tax on imports) is feared to be a major headwind for the massive U.S. LNG export projects as China is the second biggest importer of the fuel behind Japan.
Let’s look at the potential implications for LNG exports in light of the bitter and protracted trade dispute between two world’s largest economies. We also examine how this escalation of the tariff war will impact the future U.S. LNG projects and the billions of dollars poured into these plants, as well as the effects on Cheniere Energy, Inc. LNG – the U.S.’s only listed LNG export pure play.
U.S. Companies Look to Take Advantage of Cheap Domestic Natural Gas
Driven by shale extraction, natural gas output in the United States have climbed to record levels.
The EIA forecasts that U.S. will produce 90.7 billion cubic feet a day (Bcf/d) of dry natural gas this year, up from the 2018 average of 83.4 Bcf/d - a record high for the second consecutive year. The agency also projected that domestic gas output would rise to an all-time high of 92 Bcf/d in 2020.
Soaring volumes are weighing on the outlook for prices. Meanwhile, companies like Cheniere Energy foresees the fundamentals of LNG to be favorable in the long run, considering the secular shift to the cleaner burning fuel for power generation worldwide and in the Asia-Pacific region in particular. With domestic prices remaining constrained on the back of abundant supplies, the company sees a big opportunity in selling U.S. natural gas production at higher prices overseas.
China: Major Driver of LNG Demand Growth
Per the Anglo-Dutch energy giant Royal Dutch Shell plc’s RDS.A 2019 LNG Outlook, LNG demand reached 319 million tons last year – up by 27 million tons from 2017 and significantly higher than the 100 million traded in the year 2000. The 300+ million tons of LNG trade in 2018 was enough to power about 643 million homes.
Global LNG demand is likely to continue growing for the next few years and is projected to rise to around 384 million tons per annum by 2020. Supplies from Chevron-led CVX Gorgon and Wheatstone mega-projects in Australia are already being absorbed by the strong demand through long-term contracts of up to 20 years.
While the increasing demand for gas in the European power sector will be a key factor in the near-term LNG supply rise, the consumption boost is primarily set to come from Asian importers like China, India, South Korea and Pakistan as part of efforts to switch from coal and heating oil for environmental reasons.
Japan remains the world's largest buyer of LNG but China leapfrogged South Korea to take the second place in 2017. As the nation transitions from coal to natural gas, China’s imports of LNG rose 40% in 2018 to 16 million tons.
Investors should also note that China's crackdown on pollution has created a long-term positive trend for LNG demand growth with the country required to buy roughly 40% of its overall consumption in the face of domestic production shortage. Meanwhile, the comeback of nuclear power in Japan is cutting into the demand for gas-fired power generation and, by extension, LNG demand.
Cheniere: The First Company to Export LNG from the United States
While there are a number of North American LNG export projects lined up for Federal Energy Regulatory Commission (FERC) nod, Cheniere Energy’s terminals in Louisiana and Texas, Dominion Energy Inc.’s D Cove Point export plant in Maryland and Sempra Energy's SRE Cameron LNG in Hackberry are the only ones operating currently.
Being the first company to receive FERC approval to export LNG from its 2.6 billion cubic feet per day Sabine Pass terminal in Cameron Parish, Louisiana, Cheniere Energy certainly enjoys a distinct competitive advantage.
It’s true that Cheniere Energy is not entirely dependent on a single country, with the company boasting of a diversified customer base having shipped LNG cargoes to 32 different nations and regions worldwide. Still, it must be admitted that China is a leader in global LNG import growth and the country is a major area of thrust for Zacks Rank #3 (Hold) Cheniere Energy, which already has two long-term supply agreements signed in the country.
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According to consultant Rystad Energy, LNG demand from China is expected to reach 95 million tons in 2025, turning the country into the world's biggest importer. On the other hand, going by the existing sanctioned projects, U.S. volumes of LNG exports is set to rise almost four-folds by the same timeframe to 84 million tons per annum.
But with China targeting LNG from United States for import levies as part of its tit-for-tat tariff measure, there is a risk that U.S. exports would become uncompetitive. Moreover, the LNG projects aiming for final investment decision – including Cheniere Energy's Sabine Pass Train 6 and Tellurian Inc.'s TELL Driftwood LNG – might be adversely affected as these capital-intensive developments must secure long-term contracts to ensure multi-billion-dollar financing. As it is, LNG prices are on a downward spiral on estimated supply growth, mostly from the United States.
The Chinese buyers are also on the lookout for purchasing natural gas from non-U.S. LNG suppliers, which could jeopardize the likes of Cheniere Energy's revenues, since it enjoys a dominant position in the U.S. LNG export market. Cheniere Energy will reportedly supply about $18 billion of natural gas chilled to liquid form as part of a long-term contract with China’s state-owned Sinopec SNP. However, the agreement will be formally signed only after the trade tensions are resolved.
Therefore, a potential lengthy U.S.-China trade war could be a big letdown for the American LNG exporters and certainly pose risk for the future projects.
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