Pipelines of the Sea: 3 Ways to Play the LNG Shipping Bonanza

LNG exports are a fast-growing global industry that is riding a mega-trend likely to last for decades. Short-term weakness in this industry is likely to offer investors an attractive entry point for superior long-term positions.

Apr 30, 2014 at 10:00AM

Shipments of liquefied natural gas (LNG) are predicted to grow substantially and remain strong for decades. This megatrend is likely to be powered by several factors. First, global population and economic growth in developing nations will spur global demand for gas, both as an energy source and for industrial uses. In addition, cleaner burning natural gas will be an ecological boon to many developing nations that are struggling with pollution caused by coal- and oil-burning power plants, such as China. Finally, the U.S. fracking boom will provide a growing supply of friendly gas to America's allies, such as Europe and Japan, who currently get much of their gas and oil from Russia, improving geopolitical security. 

The following three companies (and partnerships) offer long-term investors an excellent opportunity to cash in on this megatrend, (each with a slight twist to the general positive industry picture). 

Teekay LNG Partners (NYSE:TGP), is the world's second largest independent owner of LNG tankers. Its total fleet consists of 88 ships, 34 LNG tankers (26 current and six on order), 33 LPG (liquefied petroleum gas, ie propane and butane) tankers, and 11 conventional oil tankers. Teekay's LNG fleet is just one ship shy of being the largest in the world yet only represents 9.4% of the global fleet. This illustrates how big of a growth runway exists in this industry for consolidation, (growth through acquisitions).

The partnership targets long-term contracts of 10-25 years in length with stable third parties such as ConocoPhillips and Total. The average remaining contract backlog is 13 years for LNG, seven years for LPG and six years for conventional oil. The total backlog is worth $6.9 billion in guaranteed income. This supports the 6.4% yield with management guiding for 2% distribution growth in 2014 and 4% in 2015. The short-term weakness in LNG pricing is only projected to last into 2015 and five of Teekay's six new builds are scheduled for delivery in 2016-2017. By that time LNG tanker rates should increase from their current $70,000/day levels back toward their former highs of $140,000/day. Thus investors should expect long-term distribution growth to exceed the 4% projected for 2015. With the rule of thumb for total returns being yield+distribution growth, investors can expect Teekay LNG Partners to beat the market's long-term growth rate (1871-2013, 9% CAGR).

Golar LNG Limited (NASDAQ:GLNG) is the general partner of Golar LNG Partners.  It owns 39.4% of the MLP's units as well as a 2% general partner position with its inherent IDRs (incentive distribution rights). 

An exciting development for the company is the potential to expand into FLNG ships (floating liquefaction ships). These ships pose an opportunity to take natural gas from land-based pipelines, liquefy it, and load it into LNG tankers far cheaper than land-based terminals. Land-based liquefaction facilities such as Cheniere Energy Partners' Sabine Pass terminal cost approximately $600/metric ton of capacity. Golar's FEED study indicates that the company's FLNGs could do the same for just $400-$500/metric ton. Currently Golar is studying the possibility of converting three existing tankers (of its five tankers) into FLNGs.

Additional growth will come from 13 new builds being delivered by November 2015. Three of these are FRSUs and 10 LNG tankers. Only two of these ships have contracts (six and eight years in length) so Golar is heavily exposed to the short-term drop in LNG tanker rates. The company is considering dropping down several of these vessels to its MLP. This would generate immediate income as well as increase its MLP's distributions (generating IDR revenue for the parent company). 

In the last 3.5 years the company's dividend (current yield 4.2%) has grown 80% (18.2% CAGR). The company's IDRs (from its MLP) are at 25%. As the MLP's distributions grow the IDR will increase to 50% (meaning 50% of all marginal revenue goes to the parent company). This means much higher fees for the parent company (IDRs have already increased by 300% since 2012).

Golar LNG Partners (NASDAQ:GMLP) is a MLP spinoff from Golar LNG Limited. It went public in 2011 with four LNG tankers and since that time has acquired total or partial stakes in four FSRUs (floating storage and regasification units). These are ships that take LNG from a tanker and convert it into usable gas that can be loaded into pipelines for distribution. It has an agreement with Golar LNG limited to purchase a fifth FRSU and has located a sixth purchase candidate it hopes to acquire within the next year. 

The partnership's current contract backlog stands at an average length of 7.1 years and is worth $2.5 billion in guaranteed income. Only one contract is expiring within the next two years (Q1 2015). The current distribution coverage ratio stands at 1.32 so the 7% yield is secure and likely to grow in the future (growth rate since IPO 11.8% CAGR).

Bottom line
Through 2015 short-term weakness in LNG tanker shipping rates will likely create good buying opportunities in the sector. This will give long-term investors great opportunities to participate in the upcoming bonanza by locking in high yields and probable capital gains. 

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