Global gas oversupply extended
For LNG sellers, 2017 threw several lifelines to lift demand well above industry
expectations. A new president in South Korea, accelerated Chinese coal-to-gas
switching, and Japanese delays to nuclear restarts all meant much stronger
demand. Off-setting this was the pricing for new and re-priced contracts falling to
an all-time low of ~11%. Looking ahead, we see global oversupply from
operating and under construction projects lasting until 2022, but including
advanced projects, this extends until 2027. Additionally, two factors could
shift oversupply out further, export plants running above nameplate and the rise
of renewables.
Contracts the key – when lawyers dictate earnings
Compounding the problems for LNG sellers, between 2018-2020 15% of global
LNG supply, ~43Mt, will come off legacy long-term contracts, with another 42Mt
between 2021-2023. The producers with the largest exposure to legacy
contracts prior to 2020 are BP, Petronas, and Shell. Adding an additional layer
of risk are the volumes up for pricing reviews. There are 187Mt of supply under
long-term SPAs that will come up for re-pricing before 2020, and a further 146Mt
between 2021-2023. Publicly available arbitration decisions over the past
few years have all been in favour of the buyers, with spot prices judged to
be at least part of the market price. For pricing reviews we see those with the
largest pre-2020 exposure as Petronas, Shell and Woodside. Using recent
examples of slopes falling to ~11% from >14% we see a substantial risk for
sellers earnings from both these factors.
Pricing – storing volatility
The significant contributor to the volatility in LNG prices has been the lack of
LNG storage capacity in China and start-up delays from new projects. We
anticipate this volatility diminishing as gas storage capacity in China is
completed by Sinopec and CNOOC, and many of the delayed Australian and
US projects ramp-up. Post the CY17/18 winter we expect pricing to range
between US$4.5-7.5/mmbtu. In combination with the substantial volume of
legacy contracts up for renewal and most buyers being unwilling to commit to
contracts with slopes above 13% we have lowered our long-term LNG price
to ~US$7.5/mmbtu in real terms.
Stock selection – OilSearch is our top pick, TOTAL/Kunlun
are well positioned, Inpex/Woodside/BP key UP calls
Our top pick among the LNG producers is OilSearch, which has a FCF b/e of
US$32/bbl, upside through its Alaskan acquisition, and has one of the most
attractive expansion projects globally. Among the supermajors we maintain
our preference for TOTAL which has the second lowest FCF b/e in its largecap
peer group and with its ramp-up of projects and acquisitions has significant
upside in CY18. In the midstream space we like Kunlun Energy which could
see ~17% gas volume growth through coal-to-gas switching in Hebei and
Tianjin. On the negative side we see Inpex’s implied pricing of US$70/bbl from
rising Ichthys volumes not factoring in further project delays. For Woodside we
see falling oil volumes in 2018 and rising contract risk not justifying its implied
pricing US$66/bbl. And for BP, its thin pre-FID portfolio combined with high price
legacy contracts coming to an end mean downside to earnings projections.