Why So Many Energy Companies Are Cutting Their LNG Projects

Following an industry trend, Australian oil giant Woodside Petroleum recently shelved its $40 billion LNG program.

In this week's Industry Focus: Energy, Sean O'Reilly, Taylor Muckerman, and Tyler Crowe explain the context around the LNG space, and why we're now seeing such sharply declining interest in it. Then the team looks at this week's other stories in energy -- how much Halliburton (HAL 1.11%) and Baker Hughes' (BHI) most recent troubles with the EU will hurt the odds that the merger will actually go through, and what's going on with Energy Transfer (ET 1.54%) and Williams Companies' (WMB 2.48%) strange and somewhat uncomfortable negotiations with Chesapeake Energy (CHKA.Q).

A full transcript follows the video.

This podcast was recorded on March 24, 2016. 

Sean O'Reilly: It's the 27th anniversary of the Exxon Valdez crash. All that and more on this energy and materials edition of Industry Focus.

Greetings, Fools! Sean O'Reilly here at Fool headquarters in Alexandria, Virginiaa. It is Thursday, March 24, 2016. And joining me to talk all things energy and materials are Tyler Crowe and Taylor Muckerman. How's everybody doing?

Tyler Crowe: Doing pretty good.

Taylor Muckerman: Wonderfully.

O'Reilly: We missed you the last couple weeks, Mr. Crowe.

Crowe: Well, last week, we did a pre-recorded interview anyway.

O'Reilly: That's true. Which was awesome, by the way.

Crowe: So listeners did not miss me.

O'Reilly: No, they did not miss your insights and your intelligence and --

Crowe: Yeah, yeah yeah, now you're just trying to blow smoke up my butt.

O'Reilly: Well, you know. Anyway. So, really quick, before we dive in here, Mr. Muckerman, 27th anniversary. I haven't seen that online. You were the one that told me.

Muckerman: Yeah, in a daily email from The Wall Street Journal on some things energy, they were like, the fact of the day was that it happened in 1989 on March 24. 

O'Reilly: That was a big deal back then -- why does nobody care anymore?

Muckerman: I don't know, I guess, because you haven't really seen, other than the Gulf in 2010 --

O'Reilly: Oh, yeah, do people care about BP now?

Crowe: I'm sure, in a couple days, this is going to be the fifth-year anniversary of it. I'm sure somebody will say something about it. And that may also be part of it, because the BP oil spill was that much bigger. There just might be the, "Eh, why don't we just focus on this one and stay mad at BP instead of ExxonMobil?" Aside from the Rockefeller family, who actually just divested their last shares out of their trust into --

O'Reilly: Could you believe how small the trust was, though?

Crowe: Yeah, no, not really. 

O'Reilly: I was like, wow, that's it? Anyway, for our listeners that don't know, feel free to Google it, but the Rockefeller Trust, which obviously is a legacy of one John D. Rockefeller, the founder of -- I mean, ExxonMobil is just a part of what was once Standard Oil. I mean, it was the American corporation. But I think the trust was just $130 million at last count?

Crowe: Something like that.

O'Reilly: Rockefeller was one of the world's first billionaires. Anyway. 

Moving on to the events of the day, first up, I guess it's LNG's turn to go through a bit of a rough patch, in sympathy with natural gas and oil and all that. Australian oil and gas giant Woodside Petroleum, which, they're the biggest -- correct me if I'm wrong -- Australian oil company, right? They're their ExxonMobil. They shelved plans to develop a $40 billion -- and that's U.S. dollars -- liquefied natural gas project. That's big, no matter how you slice it. Asian LNG prices have declined 45% over the past year, so I guess we can't be surprised there. As I understand it, U.S.-based LNG exports are the low-cost option just because we have so much natural gas in the continental United States. Is there a window of opportunity, as these other LNG facilities get nixed?

Crowe: I think so. We're at a point now where we had this mad rush. Back in, what was it, 2010, 2011, shale was really starting to take off, and you had the big push in, even just before that, with oil prices as high as they were, everyone was kind of looking at natural gas as a possible alternative, and LNG got really sexy for a while there. You had, like, Chevron with its Gorgon project and its Wheatstone project, and it seemed like Royal Dutch Shell brought out five different projects at the same time. Everything focused on LNG.

And now, they were starting to look at it and go, "Oh, shoot, maybe we're trying to bring too much on all at once, and the demand hasn't quite been there yet." So, we have, Woodside's is Browse LNG that's been nixed now, Royal Dutch Shell had one called Arrow LNG that it nixed last year, and then we've got two very big ones up in the British Columbia area. One is Chevron's Kitimat, and another one from Petronas called Canada LNG. Those are kind of looking a little shaky as of now. I was actually up in Canada a few weeks ago, and I was listening on the radio, and they're all worried about the Northeast gas fields in British Columbia laying off people left and right, because it's looking like these LNG facilities might not go through.

Muckerman: And a lot of those are due to environmental issues in Canada. They've been going back and forth on that for the past three years or so. So, yeah, those are both still on the fence. 

O'Reilly: I was going to ask you, Mr. Fool Canada himself, Taylor, how do you see this shaking out, not only for U.S. players, but Canadian players? Do you lump Canadian LNG producers with U.S. producers?

Muckerman: Not so much. There are definitely different companies operating in both areas. But when you look at the possibility of exporting, I'm sure that U.S. producer in the Pacific Northwest could get involved with those British Columbia facilities to export natural gas due to the proximity. So, maybe some natural gas from the Bakken if there's anything coming out of there, they could, instead of flare, they could ship it to these export facilities to be converted to LNG, and sent overseas. But the U.S. has six approved facilities that are under construction right now --

O'Reilly: Wow!

Muckerman: -- to export natural gas. So we're talking about several billion cubic feet per day of export capacity. And the Sabine first train just came this year, so we're seeing a lot of progress there in the U.S., and not so much elsewhere in the world.

Crowe: Yeah, I was actually looking at Cheniere Energy's (LNG 0.96%) investor presentations yesterday, and the total amount that's expected to come online between now and 2025 in the United States alone is 50 million tons per year of LNG.

O'Reilly: Really quick, before we move on, either of you, maybe Taylor, what is LNG primarily used for these days?

Muckerman: The ships are going to start using it as power to transport themselves while they're carrying the LNG. But then, once you get it to an import facility, you can, I guess for lack of a better term, thaw it out, and then use that natural gas as a power source.

O'Reilly: OK, so once you raise the temperature, it becomes regular old natural gas?

Muckerman: Yeah, it turns to the gas state. When you look at the spreads between natural gas in the U.S. and natural gas in, say, Asia and Europe as well --

O'Reilly: It's huge, right?

Muckerman: It was a lot bigger. I'm not sure if it's still as wide as it was. But evidently, it's still economical for companies like Cheniere to liquefy their natural gas, ship it, and then regasify it, and still have a profit there to be made.

O'Reilly: Got it.

Crowe: Yeah, and, actually on a slightly small, maybe more of a longer-tail sort of approach to LNG is, if you look at some of the domestic players in the United States, they're actually looking to build natural gas engines that run on LNG rather than, like, the gaseous state of natural gas, basically because LNG itself is a more energy-dense product. One of the biggest reasons we've had a hard time replacing diesel and gasoline around the world --

O'Reilly: There's so much energy packed in there.

Crowe: There's so much energy packed into it. So, natural gas, it's in a gaseous state, it doesn't have the energy density. So there's a couple of companies like, Clean Energy Fuels is actually building LNG fueling stations --

O'Reilly: Don't they have, like, 500 already or something?

Crowe: That's compressed natural gas as well. But there is a little bit of the idea that you could use the energy density of LNG to help replace the traditional gasoline market, getting into things like long-haul trucking and things like that. It's a pretty long tail, because, I mean, handling liquefied natural gas at its supercooled state would be very difficult to do on a small scale. But it's an idea.

O'Reilly: So, guys, this is a story that we have talked about before, will definitely talk about again, and that is, the Halliburton-Baker Hughes merger. Not only has the deal been held up by the European Union, but now, French oil giant Total has voiced objections as well. Taylor, I want to start with you. Is this the final nail in the coffin? When are we going to call this thing?

Muckerman: I don't think so. Both companies, the deal for them is April 30 is when it can be terminated. It's not an automatic termination, but that's when Baker Hughes can say this isn't going to work --

O'Reilly: And then a big check is written? [laughs]

Muckerman: Yeah, then the $3.5 billion check is written by Halliburton. So they still have over a month before that happens. But, even still, I believe both parties would want this to go through. From that point of view, I don't think this is the final nail in the coffin. I just don't understand how they could have originally, back in July, been told that they didn't -- this is not Halliburton in particular, they haven't specified which company hasn't given details that they need. But, this happened last July, the European Union said they needed more crucial details that were missing. And that's what they're saying now. So I don't understand, unless they need details on an ongoing basis as things change, then this is kind of vexing me right now, I don't understand it.

O'Reilly: Tyler, were you surprised when Total came out? Because you were saying that they're not the only big oil company that's saying, no, we don't want this.

Muckerman: You have to understand the interest, right?

Crowe: Yeah, why would any oil and gas producer want less competition from its service providers? I mean, it's basically almost like a transfer of power, if oil service providers get bigger, they can command better pricing power, they can charge more for what they're doing, because they can basically say, hey, there's less of us involved, we don't have to undercut seven players, we only have to undercut three, or in this case, two versus three players. So, of course they're going to come out and say, we don't like it. And of course, Halliburton-Baker Hughes are going to do everything in their power to try to get it done, simply because, like you said, better pricing power. My biggest fear of, I guess what we could call a zombie story, because it's been going on for well over a year now. Close to 18 months, I think.

Muckerman: Yeah, November is the monthly anniversary.

O'Reilly: We talked about this on our first episode together, all three of us. [laughs]

Crowe: Yeah. So, my one fear for anybody invested in this would be, with all the regulation and approval that has to go through, that they actually have to divest themselves of so many different options and services that they're really not a whole lot bigger than Halliburton was originally. That would be my one thing that would get me hung up on the whole process.

Muckerman: I definitely get that, but from everything I've read, they're not really hung up on the divestitures at the moment. I mean, they're just hung up on a lack of details. Could that lead to more forced divestitures? Yes, but they're not really specifying what they're looking at exactly. They've already announced that they're going to sell Baker Hughes' offshore drilling and completion fluids division, and a few of their overlapping on-land businesses. And if they do sell it all, then they're flush with cash, right? So, maybe they go out and really hammer home on some of their... they already are at an advantage, and they just extend that, but they're more concentrated.

O'Reilly: Cool. Before we move on, I wanted to point out to our listeners that April is financial literacy month. In that spirit, we are giving away 10 books to 10 lucky winners. These books include favorite financial picks from David Gardner, Morgan Housel, and so many more. To enter to win, just go to podcast.fool.com and click on the Super Podcast link at the top of the page. Once again, that is podcast.fool.com.

So, moving on, this is actually another ongoing story that we've had. You guys will remember --

Crowe: It doesn't seem like we have any quick-hit, like, something happens. It just seems like nowadays, all our stories are just like, "Man, this just keeps going on."

O'Reilly: Dearth of material, it's a sad thing.

Crowe: I guess.

O'Reilly: But our listeners will remember and I'm sure you guys remember, everybody thought that in a bankruptcy court, distribution contracts between a producer and a pipeline company would be held as sacred. What were we talking about, they went out as far as five or six years in a lot of cases? In a great piece put together by the Fool's own Matt DiLallo, we recently got the details on some contract negotiations between -- and I'm just going to say the word "troubled" -- Chesapeake Energy. What are their bonds at, 10, 20 cents on the dollar? Anyway.

Crowe: Not good.

O'Reilly: Not good. But they're negotiating with Energy Transfer Equity and Williams Companies, and based upon the lengths of the contracts, it seems like these two pipeline distributors, Energy Transfer and Williams, they're not too worried about Chesapeake. How surprised, Tyler, were you when you read this?

Crowe: Either they're not worried at all or they're really worried. I mean, it could go either way. 

O'Reilly: This is kind of a Catch-22.

Crowe: The whole gist of it is that Chesapeake Energy is looking not good, and there's a very real possibility --

O'Reilly: Because they're primarily a natural gas producer, and nat gas is still less than $2.

Crowe: Stupid cheap, and there's a possibility that it could go under. So, what has happened here is Energy Transfer and Williams Companies, two companies that actually rely pretty heavily on --

O'Reilly: Do you know the breakdown?

Crowe: Williams Partners, so, the subsidiary of Williams Company, 20% of their revenue comes from Chesapeake Energy.

O'Reilly: Wow.

Crowe: So, basically, the idea is, "We're going to cut them a little bit of a break on how much were going to charge to use our gathering systems and pipeline network distribution, in the opportunity that they'll have higher volumes in the coming years and we'll make it up in a couple years once these guys start to head back in the right direction." So there's that idea, and that's how they pitched it as the upside of, "Yeah, we'll give them a little break now, but we really see the opportunity to gain in a couple years with the higher volume growth." I think the bigger question is, is Chesapeake going to be around long enough to actually get the higher volume growth? And that's the reason I look at this deal and go, yeah, they're cutting how much they're charging Chesapeake because Chesapeake can't pay it, and if they don't, they're going to have to find a whole new company to get it from.

O'Reilly: Yeah. So, Taylor, do you think that [laughs], with what Tyler said, that they're not worried at all, or they're actually really worried and trying to save [laughs] them?

Muckerman: [laughs] I'm going to have to agree with him on this one.

O'Reilly: It's kind of screwy. Anyway. So, we just got an update on the Sabine situation -- I said that right, right?

Crowe: Yes.

O'Reilly: In a follow-up to what we were talking about a couple months ago, the judge actually ruled, and it was kind of hinted, when we talked about this, that oil driller Sabine Oil & Gas Corp., which filed for bankruptcy in July, could reject contracts with two pipeline operators, HPIP Gonzales Holdings and Cheniere Energy's Nordheim Eagle Ford Gathering -- wow, that's a long name.

Crowe: That's the one thing with energy companies.

O'Reilly: They are not creative.

Crowe: They have horrible names. There are the worst names in energy.

O'Reilly: I'm really surprised at this. Why bother having a contract, then?

Crowe: I think Taylor's rant a couple weeks ago was a perfect example of that.

Muckerman: [laughs] Thank you very much; I'm tipping my hat.

Crowe: That's another thing, when we look at this Chesapeake deal that they're doing with Williams Companies, basically, this court decision says, "Yeah, if a company is in bankruptcy, they can rip up their contracts and not make it worth it."

O'Reilly: So that's what Chesapeake is negotiating.

Crowe: You have Chesapeake, who is teetering on bankruptcy, then Williams might be like, "Well, if we renegotiate a better contract now, that helps them get through, they won't go bankrupt and completely rip up the contract and have to go to somewhere else. Because then all that development we've done to work with them would be flushed down the toilet."

O'Reilly: OK, so, bottom line, this probably means everybody is in trouble.

Crowe: A little bit.

O'Reilly: OK, cool. [laughs]

Crowe: Maybe that's me being a little bit more pessimistic. But that's kind of my take on what's going on.

O'Reilly: And, winding down here, we have a listener question. Time for mailbag. Our listener writes in -- and I'm paraphrasing here -- "Thanks for the recent podcast on the battery industry. Do you think there are threats to the industry at large? Also, with Tesla (TSLA -1.92%) building its Gigafactory, would buying Tesla be the best way to invest in the future of battery usage? Thanks; love the podcast."

Crowe: I guess I'll take that, because I did the interview last week with Steve Levine on his book The Powerhouse. So, what are the biggest threats to the industry? Well, one of the things that you really have to consider --

O'Reilly: Cheap oil.

Crowe: Well, I was just going to say technology development in general. We're looking at a product that is still technologically a little bit incomplete. We've figured out a pretty good solution, but we haven't figured out the ideal solution, the one that's actually going to be able to compete heads-up, no subsidies, no government favorability.

O'Reilly: Because, technically, a lithium ion battery is a chemical reaction. They lose their efficiency after -- correct me -- just a couple of years. It starts dropping a little bit.

Crowe: It's on charge cycles, it's not actually on any specific timeline. But, how many times that you charge and discharge the battery, there are components within the structure of the battery that will start to break down as those ions transfer back and forth. So, the biggest threat, basically, is that today's technology gets disrupted and thrown out the window within 18 months. If you look at anything -- I think a great example is solar panels. If you look at how much efficiency has improved on solar panels over the past several years, and you can even go back 10, 15 years, that it's gone so fast that a 10-year-old solar panel nowadays is almost obsolete.

O'Reilly: Wow.

Crowe: At least, in comparison to --

O'Reilly: Yeah, some solar panels right now put out by... was it SunPower? Yeah, they're hitting 21%?

Crowe: 21%-22% efficiency levels.

O'Reilly: Which is crazy!

Crowe: Which is almost double what it was 10-15 years ago.

O'Reilly: If you read the book The Martian, I hate to plug a fiction book that was just made into a movie, but, he was talking about how the solar panels on the Rover were like 10%. It's just crazy what they've been able to do in the last five to 10 years. 

Crowe: Yeah. So I see that as the biggest threat. Basically, if you are making an investment in the industry, it could get thrown on its head within 18 months, just on the simple progression of the industry. We've seen this. Everybody talks about the Solyndras and the A123s and all these companies that have gone bankrupt. But that's just how fast the technology is evolving. Somebody comes out with a great technology, it looks like they can sell and market it, commercialize it, and then boom, 18 months later it's an obsolete product, and it's very, very difficult to catch up.

O'Reilly: So, Taylor, you get the last word here. What are your thoughts on Tesla? Do you think they got ahead of themselves with the Gigafactory? Was that a necessary risk that they had to take in light of what Tyler said?

Muckerman: I do think the Gigafactory is going to be a benefit to them, if only the fact that they're going to be able to put their own batteries in their own cars. So, you eliminate some of the cost structure. So maybe it's not a play on global use of lithium batteries, but it certainly could be, if this technology is used for the foreseeable future. Another company, maybe Johnson Controls, if you didn't want direct 100% exposure to lithium-ion batteries, that's a company that is very well diversified, also mainly with the automotive sector, but their lithium-ion batteries is a segment of that business that could possibly grow if lithium-ion batteries take off in cars around the world, as Tesla and other models are proving possible.

O'Reilly: Awesome. Thanks for your thoughts, guys. See you next week.

Crowe: Cheers.

Muckerman: Yep.

O'Reilly: If you're a loyal listener and have questions or comments, we would love to hear from you, just email us at [email protected]. Again, that's [email protected]. As always, people on this program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against those stocks, so don't buy or sell anything based solely on what you hear on this program. For Tyler Crowe and Taylor Muckerman, I'm Sean O'Reilly. Thanks for listening, and Fool on!