Global LNG
Sink without a tap
Paul Sankey
Research Analyst
(1) 212 250 6137
paul.sankey@db.com
Ryan Todd
Research Associate
(1) 212 250 8529
ryan.todd@db.com
Fundamental, Industry, Thematic, Thought Leading
Deutsche Bank Company Research's Research Product Committee has deemed
this work F.I.T.T. for investors seeking differentiated ideas. Here our oils team
extends an ongoing series of thought pieces on liquefied natural gas (LNG).
Deutsche Bank Securities Inc.
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DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1
FITT Research
Top picks
Total SA (TOTF.PA),EUR52.45 Buy
Chesapeake Energy (CHK.N),USD64.00 Buy
Range Resources (RRC.N),USD67.00 Buy
Woodside Petroleum (WPL.AX),AUD63.75 Buy
Companies featured
ExxonMobil (XOM.N),USD87.99 Hold
2007A 2008E 2009E
EPS (USD) 7.20 8.14 9.22
P/E (x) 11.6 10.8 9.5
EV/EBITDA (x) 6.2 6.8 6.5
Total SA (TOTF.PA),EUR52.45 Buy
2007A 2008E 2009E
P/E (x) 10.2 8.1 6.9
EV/EBITDA (x) 4.93 4.04 3.43
DB EPS (EUR) 5.37 6.45 7.57
Chevron (CVX.N),USD100.37 Hold
2007A 2008E 2009E
EPS (USD) 8.00 9.92 11.84
P/E (x) 10.3 10.1 8.5
EV/EBITDA (x) 4.8 5.5 4.6
ConocoPhillips (COP.N),USD95.78 Hold
2007A 2008E 2009E
EPS (USD) 9.13 10.69 12.04
P/E (x) 8.4 9.0 8.0
EV/EBITDA (x) 5.2 4.9 3.3
Marathon Oil (MRO.N),USD53.07 Buy
2007A 2008E 2009E
EPS (USD) 5.45 5.73 7.50
P/E (x) 10.0 9.3 7.1
EV/EBITDA (x) 5.3 4.6 3.6
Hess Corporation (HES.N),USD129.73 Buy
2007A 2008E 2009E
EPS (USD) 6.04 8.39 10.73
P/E (x) 10.2 15.5 12.1
EV/EBITDA (x) 3.7 5.2 4.2
Petro-Canada (PCA.TO),CAD59.05 Buy
2007A 2008E 2009E
EPS (CAD) 5.51 7.32 8.36
P/E (x) 9.3 8.1 7.1
EV/EBITDA (x) 3.9 3.1 2.9
BP (BP.L),GBP592.25 Buy
2007A 2008E 2009E
P/E (x) 12.4 8.4 7.5
EV/EBITDA (x) 8.73 6.16 4.84
DB EPS (USD) 0.92 1.37 1.54
Royal Dutch Shell plc (RDSa.L),GBP2,080.00 Buy
2007A 2008E 2009E
P/E (x) 9.3 8.2 7.5
EV/EBITDA (x) 10.10 4.51 4.15
DB EPS (USD) 4.04 4.93 5.40
ENI (ENI.MI),EUR24.69 Buy
2007A 2008E 2009E
P/E (x) 8.9 8.4 7.8
EV/EBITDA (x) 5.31 4.27 3.66
DB EPS (EUR) 2.82 2.94 3.16
Repsol (REP.N),USD36.56 Hold
2003A 2004E 2005E
P/E (x) 7.9 16.4 17.8
EV/EBITDA (x) 6.56 10.56 11.22
DB EPS (USD) 2.03 2.23 2.05
Santos (STO.AX),AUD21.21 Buy
2007A 2008E 2009E
P/E (x) 15.2 27.4 16.6
Div yield (%) 3.2 1.9 1.9
Price/book (x) 2.5 3.6 3.1
StatoilHydro (STL.OL),NOK197.50 Hold
2007A 2008E 2009E
DB EPS (NOK) 15.48 20.64 23.05
P/E (x) 11.0 9.6 8.6
EV/EBITA (x) 3.9 2.9 2.7
Woodside Petroleum (WPL.AX),AUD63.75 Buy
2007A 2008E 2009E
P/E (x) 25.2 20.9 15.4
Div yield (%) 2.4 2.9 3.9
Price/book (x) 6.8 7.4 6.2
Fundamental: short supply has left the US “sink” relatively empty
We have recalibrated our global LNG supply and demand model and find too much
demand even for rapidly growing supply. The US market’s size, liquidity, diversity
of supply and storage capacity make it the "sink" for LNG cargoes – but a shortage
of global natgas has left the sink without a tap of supply. The US "call on LNG"
exceeds available supply. Long term it gets worse. The expected 2007 FID of
nearly 90Mta of LNG capacity saw only 10Mta receive project sanction – i.e., a
near-term supply growth breather in 2009 will give way to shortages post-2010.
Industry: new demand centers and upstream returns
While supply struggles, demand strength continues to surprise, led by
earthquakes in Japan, droughts in Spain, and the emergence of new demand
centers in Kuwait, Singapore, Chile and Argentina – the southern hemisphere now
competes for US summer imports. Short supply has polarized returns, driving
shipping & regas often below cost of capital, yet upstream returns to > 50% IRR.
Thematic: global prices are pricing to oil parity – 60% above US prices
Strong international demand plus a security of supply and environmental premium
in Asia and Europe has left international prices set by the marginal price of
demand, pushing long-term contracts to straight line oil parity. Implied pricing of
$17/mmbtu at $100 oil ($22/mmbtu at $130) implies significant earnings upside for
those with LNG supply growth: Shell, ExxonMobil, Total and Woodside.
Thought leading: US natgas still priced to US F&D with massive spikes
Contrary to prevailing opinion that US prices must rise to attract LNG cargoes, US
gas supply growth is strong enough that we see the US market remaining
relatively insular for the next 4-5 years, with price set by domestic F&D costs.
Current costs of $3/mmbtu imply a tax/returns adjusted Henry Hub price closer to
$10/mmbtu. Yet global tightness will leave the US exposed to price spikes (likely
weather induced) up to global market levels, possibly in excess of $25/mmbtu.
Buy natgas volatility, growth LNG supply, and even US natgas
Returns in regas and ships have collapsed while those in adding LNG supply have
exploded. Most levered to LNG is Woodside (BUY). Best mega-cap plays are
RD/Shell and ExxonMobil. Favoured domestic E&P is Chesapeake (CHK). In the
past we have been right and wrong in previous LNG analysis in 2002, 2004, and
2006. The uncertainties here are inherent and abundant, especially since the
marginal balance is driven by weather.

Table of Contents
Executive summary ........................................................................... 3
A global shortage of LNG leapfrogs international prices to oil+................................................3
Risks ........................................................................................................................................4
The global shortage of LNG.............................................................. 5
The global shortage of energy – LNG and distillate particularly ................................................5
The global shortage of energy and LNG – too much demand...................................................6
Supply: growing but less than expected or needed................................................................10
Costs and returns dynamics ........................................................... 14
Returns dynamics have shifted dramatically ...........................................................................14
Even if below demand prices; LNG supply costs have risen ..................................................15
Excess of shipping supply over demand.................................................................................17
Excess Regas capacity............................................................................................................18
Price dynamics................................................................................. 19
Price dynamics shift from supply cost to demand price .........................................................19
Price implications – Oil vs. Gas and the move to parity ..........................................................20
Higher prices in competing regions ........................................................................................22
The WACOG leapfrog and competition from contracted markets ..........................................23
Buyers are more worried about security of supply elsewhere................................................24
US imports are not price sensitive but rather attracted by storage.........................................25
The US gas market is on its own – LNG can only help in extremes........................................27
So what’s the weather forecast? ............................................................................................29
Corporate impacts – growth and returns ...................................... 30
The best and the rest in global LNG........................................................................................30
Who has the growth? .............................................................................................................32
Who delivered?......................................................................................................................34
Valuation and risk............................................................................ 35

Executive summary
A global shortage of LNG leapfrogs international prices to oil+
The world is short energy, and LNG is no exception. Spot global natgas prices are 60%
higher than US prices (Asian LNG is at oil parity, or $17/mbbtu at $100/bbl oil, implied
$22/mbbtu at current $130/bbl) and likely to stay that way. With continued operational
difficulties and project delays, we assume supply is short for years, even with a 12% jump in
global LNG supply ‘09/‘08. We believe that average US prices will tend to be set by US F&D
costs ($10/mmbtu), but with potential for massive upside price shocks to global prices when
imports are needed – on our numbers the US market is around 2 bcf/d short for the next
three years – which could be as bad as an 8 bcf/d shortage in a cold winter. That implies
excursions towards $25/mmbtu, for example if we have a cold winter this year.
In this note we re-examine supply demand balances and focus on oil vs gas price dynamics.

We see a greater US “call on LNG” than there is available LNG supply. There are major
question marks, the four largest being 1) Russian gas supply; 2) timing on Indonesia’s
ongoing switch from being the world’s largest LNG exporter to being a major user of its own
LNG; 3) Japanese nuclear power performance; and finally 4) weather and within that the
small matter of US natgas supply and demand balances. US supply is reacting well to high
prices (geologic peak oil proponents take note), demand is also robust. We see global prices
at (smoothed) oil parity, but the potential for extreme volatility in US natgas prices.
A key point is this: rival gas markets are prepared to pay more for LNG supply than US buyers
for two simple reasons beyond a weak dollar and strong global demand:
􀂄 Security of supply, with Europe excessively dependent on Russia, and Asia short
domestic supply and short pipeline supply, gives LNG prices in these regions a premium
vs US markets that are 99% supplied from US domestic supply and friendly Canada.
􀂄 Environmental premiums are higher ex-US. For example it is imperative for China to burn
more gas. Therefore the US is effectively priced out of the market by some way, and the
only import volumes are basically low season excess cargoes looking for storage
With energy short, we clearly see an argument for natgas premium over oil based on those
two factors. However an equal offset in our view is the convenience premium of oil. That is,
LNG supply has under-delivered on a multitude of supply issues and even when projects go
well takes around six years from first well to first LNG. So in the interim there is a massive
squeeze on distillate, which acts as a re-balance in relative oil vs. natgas prices.
Because supply is short, regas, storage and ships are in excess supply and therefore even
the US storage “premium” will erode over time. The US is a “sink”; a massive market that
can absorb excess volumes; but supply is super-tight globally, prices are higher elsewhere,
hence there is no tap.
A key function of the global LNG shortage has been a massive skew in the returns in the
global LNG chain. Previously, it was assumed that upstream gas production would return
15% IRR; liquefaction a similar amount, shipping 12%; and regasification 10%. However
regas and ships are relatively easy to build, and we now have too much of both – returns
here have collapsed, in many cases to below the cost of capital.
By contrast, the difficulty in adding LNG supply has exploded returns in production and
trading of LNG supply to the upside, with 50%+ IRRs for those who can grow production. By
extension, finding growth LNG plays is easier said than done. The industry is dominated by
super-major oil companies with huge portfolios and less direct leverage. Most levered to
LNG is Woodside (BUY). Best mega-cap play are RD/Shell and ExxonMobil. The biggest driver
of domestic natural gas growth are shale resource plays, led by Chesapeake (CHK), who has
the leading North American land position with 90% of its reserves unhedged and exposed to
future natural gas pricing strength. Other recommended names are Range Resources (RRC),
EXCO Resources (XCO) and XTO.
Risks
In the past we have been right on LNG (supply is short, analysis 2004, 2006) and wrong on
LNG (global gas prices cannot rise above $4/mmbtu because of abundant LNG supply, 2002).
The uncertainties here are inherent and abundant, especially since the marginal balance is
driven by weather. In this note we briefly show which companies performed best against our
expectations, but past performance is no guarantee of future success – more an indicator,
and even then dangerous if expectations get too high.

The global shortage of LNG
The global shortage of energy – LNG and distillate particularly
The global shortage of LNG – particularly acute in winter – that we first wrote about in 2004
(“Global LNG, Exploding the Myths”) and again in 2006 (“US LNG: waiting for the cavalry”)
has persisted and is expected to remain even though there is a huge jump in the size of the
LNG market forecast over 2008/2009. Our experience tells us that this supply growth is likely
to disappoint, just as demand is likely to surprise.
Anyway, the longer term picture looks tight, with enough creditworthy buyers anxious to
commit their demand needs, any weakness in the market is likely to be pounced upon by
nervous buyers.

Of course, demand cannot exceed supply, and our analysis suggests that based on recent
pricing and supply dynamics, the market with unmet LNG demand will be the USA. We
address the issue of global and US demand in the next section.