In this week's episode of Industry Focus: Energy, The Motley Fool's Nick Sciple and Jason Hall dive into the liquefied natural gas industry. They'll discuss how the modern LNG industry developed, why this corner of the energy sector is so attractive for investors, some of the different ways that investors of every risk tolerance can invest in it (with stock picks!), what investors who want to keep tabs on the space should watch, some risks to be aware of, and more.

Among the companies they'll talk about are Cheniere Energy (NYSEMKT:LNG), Tellurian (NASDAQ:TELL), NextDecade (NASDAQ:NEXT), Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B), Dominion Energy (NYSE:D), Kinder Morgan (NYSE:KMI), and Chart Industries (NASDAQ:GTLS).

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Nov. 21, 2019.

Nick Sciple: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today is Thursday, Dec. 5, and we're discussing LNG. I'm your host, Nick Sciple, and today I'm joined by Motley Fool contributor Jason Hall via Skype. How's it going, Jason?

Jason Hall: Hey! How you doing, Nick?

Sciple: I'm doing OK. Just for our listeners, we are pre-recording this show on Nov. 21, so some things may have changed. The LNG story, though, is really long term, so probably not a ton has changed of the thesis that we're going to talk about today.

Just off the top of the show, Jason, for folks who aren't familiar with what LNG is, what does it stand for and what is it?

Hall: Liquefied natural gas. Which is not natural gas liquids. Let's say what it's not first. Natural gas liquids are things like isobutane, propane, and that kind of stuff. Liquefied natural gas is natural gas that at ambient temperature is a gas, it's gaseous. Here's the thing. If you want to transport a large amount of it, in terms of energy quantity, when you liquefy it, you supercool it to like 260 degrees below zero or something like that, and it becomes much, much more dense. So then, it makes it a lot easier to get a lot of it in remote locations, or, if you want to, say, get some to Japan, where they don't have a lot of natural resources, you liquefy it, and that's how you do it, because it makes it much, much smaller and much more dense in terms of its energy density.

Where this fits into the energy future is, as everybody's noticed, coal's losing its luster. Even nuclear is in a lot of places because of the perceived environmental risk, disaster risk. A lot of places in the world are starting to move away from nuclear. It just so happens that North America has a century's worth, probably a century and a half's worth of natural gas, and there are a lot of companies that are working on building large-scale liquefaction facilities to turn this natural gas into a liquid, put it on container ships, and send it to the demand centers in the world like Southeast Asia, Japan. Mainland China is going to be a big demand source for it. So, huge, huge potential.

Sciple: You mentioned the amount of supplies of natural gas in the U.S. We've discussed in the past on this show about how fracking, the advent of that technology really released huge amounts of hydrocarbons that we just couldn't get access to before. Natural gas has been a huge part of that. That's why we really expect some massive growth in this space going forward. Some analysts are expecting the global LNG market to grow at a 4% annual rate through 2035. You might say, "4%, that's not that much." When we're talking about the global energy market, that's a massive growth rate year over year. The U.S. is going to be a huge part of that. The U.S. is expected to become the world's largest exporter of LNG within five years. We're currently the third-largest exporter. It wasn't long ago that we weren't even a rounding error when it came to being part of that business. Global deliveries to U.S. LNG gas terminals hit a record in 2019, and that is really expected to continue to grow.

You mentioned growing natural gas demand. A big part of that is just emissions. When you look at natural gas, it's about 45% to 55% cleaner than coal. So, obviously, [there's] a huge push for a cleaner environment. We have this massive supply available. And then, another important aspect of this, Jason, I want you to touch on a little bit, is because we have such a huge supply of natural gas in the U.S. right now, prices in the U.S. are significantly lower than the global average prices, global benchmark prices, which creates an opportunity for these LNG exporters.

Hall: Yeah. It's interesting, too, the price aspect of it. A couple things. Obviously, fracking and our ability to get into shale and release these hydrocarbons has been a tremendous boon. It's driven the costs down substantially. Another thing that's happened is, it's driven the prices down. It's not just the production of natural gas itself that's driven it down. You have associated gas. For example, we'll use the Permian in Texas. Really, it's known mainly for its oil. It's one of the largest oil reserves in the world now. There's a tremendous amount of associated natural gas that oil drillers are producing, just it's coming up when they produce the oil. There's so much that a lot of it is getting flared because there's not even enough infrastructure to bring that natural gas to market. But the gas that they are bringing to market has pushed the prices down so low that natural gas producers are begging and screaming for these export facilities to get built simply so they can get access to the markets to help them realize better returns for their gas.

One thing, too. It's not just the environmental benefits of gas that's driving demand around the world. If I'm a utility, I would much rather operate a natural gas power plant than a coal plant because it's so much cheaper to maintain it. It requires less maintenance. The feedstocks are a little bit more predictable to get. You don't have to have these miles and miles of coal cars lined up. It's a more predictable source of fuel, and your operating costs beyond the cost of the fuel itself, the actual costs to operate and maintain the facility, are far, far lower. So there's a lot of operational benefits and cost benefits, on top of it just being a cleaner fuel. It's really a winning fuel versus coal beyond the environmental benefits.

Sciple: Sure. I think one other thing we should mention as well, natural gas versus coal, is how quickly you can bring power production online and offline. With a natural gas plant, you can really do it very quickly. For a coal plant, you need to be running that plant almost constantly to be cost-effective. As we see continued growth of renewables, that role for natural gas to fill in the gaps where renewables can't fill in really creates an opportunity. Do you want to talk about that a little bit, Jason?

Hall: Yeah. I think over the long term, that's where natural gas is really going to be a big winner. There are also some applications, like petrochemicals for manufacturing fertilizers and plastics and lots of other things. But really, it's going to boil down to the ability for grid operators to generate a baseload of power when you're not getting energy from renewables.

But also, a real problem, especially with solar, is that the end of the day, when the sun starts to go down and solar production just falls off a cliff, corresponds to when people are getting home from work and they're kicking on their air conditioners, turning their heaters up. So, power demand surges right when power supply from solar falls off. You need the ability to meet that peak demand. This is exactly what you were talking about with natural gas, is these peaker plants, these plants that can be quickly ramped up to generate electricity to meet that peak demand right when you're losing a key source of supply. That's only going to grow in the form of solar.

So, yeah, natural gas is a fuel that's going to have legs for a long, long time because of its affordability, its better environmental profile, and it allows them to be more flexible with the facilities that they generate power from.

Sciple: Exactly. That's created the opportunity for these exporters, this spread between supply in the U.S. and prices overseas. In addition to these big increases in demand driven by all these benefits, creates an opportunity for businesses.

OK, Jason, here on the back half of the show, I want to talk a little bit about the different ways that folks can invest to get exposure to liquefied natural gas. We're going to talk about three broad categories: pure-play exporters, picks and shovels, and then more broad exposure, integrated majors, midstream companies that all have exposure to liquefied natural gas.

First, let's talk about these pure-play exporters. First off, what are the major names in this space that are playing in this pure-play exploiting sector of the LNG market?

Hall: In pure-play, the first three that come to mind for me are, you have Cheniere Energy, which is kind of the original. And you have two others. At this point, they're almost like biotech start-ups.

Sciple: Copycats.

Hall: Yeah. You've got Tellurian and NextDecade. I think the Cheniere story is really, really interesting. If you go back in time almost a decade or so ago now -- a lot of people don't know this. It's kind of mind-boggling. About a decade ago, a little more than a decade, the general consensus in the energy industry was, the United States was about to run out of natural gas. [laughs] We didn't have any, because all of these traditional, legacy, vertical-well natural gas resources were being consumed. And the thought process then was, "We're going to have to start importing natural gas. We're going to have to start getting it from Australia. We're going to have to start bringing it in from Africa. We don't have any."

So, Charif Souki, essentially the founder of Cheniere Energy, said, "OK, I'm going build an import facility. I'm going to build it in Louisiana, Sabine Pass, and we're going to start bringing natural gas in, and that's what we'll do." And this is somebody that had never had any experience in the energy industry. He was an outsider. He has a lot of business ties in different parts of the world, so he kind of knew where the energy markets were. At any rate, he started building this business, Cheniere Energy, as an importer. Then shale happened, and fracking, and horizontal drilling happened. And over like a five-year period, all of a sudden, we were going from "Peak natural gas, we're going to run out," to, "Wow, we're going to have more natural gas than we know what to do with."

On one hand, it's like, "This business is going to die, what am I doing here?" Souki, being a very mentally flexible person, said, "You know what? Let's just start over here. We've got the basic framework in place. We need this facility to be here. We just need to use it as an export facility." Of course, the challenge is it's going to take tens of billions of dollars in investment to build the liquefaction facility to turn that gas into a liquid and then put it on the ships, versus substantially lower cost to take natural gas off of a ship to regasify it and put it into the gas pipeline system.

Anyway, long story short, Cheniere is worth what now?

Sciple: $15 billion or so.

Hall: And how much money have investors made since Cheniere went public? What's the round figures here, if you were to guess?

Sciple: 10-bagger.

Hall: Would you guess, over the past decade, 2,950%? That's pretty good, right?

Sciple: That's pretty good from when your original business model was busted before you ever got off the ground, right?

Hall: Yeah. That's essentially from the bust, about a decade ago. And it's been a bit of a roller coaster. A few years ago, it was up almost 4,000%, and then it dropped a lot during the last little oil market crash, and then it's bounced back strongly. The big thing is that this is a cash-positive business now. It generates substantial revenues from its export business. It has a lot of long-term contracts that are take-or-pay contracts. It's almost like a midstream company, only it's putting it onto ships instead of putting it through pipelines.

And there's more growth to come. The company is expanding, it's building more export facilities. I think it's adding another train or maybe two trains to its Sabine Pass facility. It's not over yet. There's still potential growth for this business as the demand will continue to grow over the next decade.

Sciple: Sure. Jason, to your point, when you talk about being a midstream player, a midstream player where these projects take years and years and years, and billions and billions of dollars of capital, just to stand up the business. So, it's very difficult for companies to come in and challenge their position. It takes a lot of time and money to do that. However, as we mentioned -- just to point out for folks, the ticker for Cheniere Energy is LNG. For Tellurian, it's TELL. For NextDecade, it's NEXT. These companies that are moving in to challenge them, to follow in their footsteps, Tellurian and NextDecade also have a long road ahead of them to build these facilities.

However, when you look at Tellurian and specifically, they benefit from a lot of that leadership that led Cheniere Energy as they scaled up to start off. Can you talk about that advantage maybe Tellurian has?

Hall: Tellurian's advantage is, it has management that's done it before. Just to use Cheniere as an example, Cheniere Energy was generating hardly any revenues at all until like 2016. If you look at the past 10 years, seven of those 10 years, this is a company that was generating maybe $150 million, $175 million a year in revenue, mainly on contracts it was locking up for when it eventually started selling gas. But it was burning through hundreds and hundreds of millions of dollars a year just to keep the lights on, pay its operating expenses, on top of the billions that it invested in building out this infrastructure before it shipped a single cubic foot of natural gas. So, all of this all of this happened. And now, here it is today. It's a big, cash-flow-positive business. It generated, I don't know, $9 billion in revenue last year, and generated $1.6 billion in positive cash flows.

Now, let's take that and look at Tellurian. Tellurian is essentially what Cheniere Energy was five or six years ago. It's a business that generates hardly any revenues at all. It's burning $115 million, $120 million in operating cash flows every year. And it's a business plan. It hasn't broken ground on its Driftwood facility that it's building in Louisiana. That's where its liquefaction terminal and export terminal will be. And it's not going to be in operation until 2023. So you're looking at three years. And that's assuming that everything happens on schedule. And, oh, by the way, it's going to have to raise, between debt, shares it's going to sell, and capital it's going to raise with joint venture partners, it's going to have to raise like $25 billion to fund the construction of that facility. And, it also has I think, three pipelines that it's trying to build, too. There's the Driftwood pipeline, there are two other pipelines that are going to connect it to various sources of gas. So, at this point, you're buying a business idea.

Now, why is Tellurian a business idea that's worth buying? Well, guess who the founder is? It's Charif Souki. He was essentially run out of Cheniere a few years ago by Carl Icahn and a few other activist investors. He left, he joined forces with a former executive from BG Group, which is a name that some people might recognize, one of the largest natural gas integrated majors in the world, that had a huge natural gas business. It was acquired by Royal Dutch Shell. So, now, you have two people who have a lot of experience in developing natural gas assets that started Tellurian. Over the past few years since they've started Tellurian, they've brought over, you can almost describe it as a murderer's row of management to run this business. What's the CEO's name?

Sciple: Meg Gentle.

Hall: Yeah, Meg Gentle. She's the CEO of Tellurian, and she was right in the middle of everything that was happening at Cheniere when they were going through the same time frame that Tellurian is now, in terms of getting funding, striking these deals with the big, integrated majors that need to get natural gas. She was right in the middle of when they were striking all these deals to get funding to build the facility, signing these long-term contracts with the companies and the countries that needed this natural gas.

If you were going to invest in a start-up business, you almost couldn't ask for a better situation than Tellurian, if you're willing to take on the risk. Which, in this case, it's really execution risk. They have to get all this capital, then they have to build miles and miles of pipelines, and then they have to build this export facility before they're going to be able to bring in a single dollar of revenue. So if you have the stomach to ride out the volatility that's going to happen -- and really, if anything, maybe look for the business case to remain strong, but look for investors to sell out and to give you an opportunity to maybe buy more over time -- this is an excellent company to do that. If you're willing to take on that risk, I'm not saying you're going to get 3,000% returns, but I think the case is pretty clean, just based on cash flows and where the market values Cheniere Energy today on a cash flow basis, this could easily be an eight-bagger in four or five years, once the facility's online and producing the cash flows that management's projecting that it will produce. This could be a $70 stock if everything works out. If everything doesn't work out and they're able to come close, this still could be a great stock to really beat the market.

Sciple: Yeah. As we spent the whole first half of this show talking about, when it comes to the opportunity that's before them, there's really no denying where the broad trend is. As you mentioned, it's execution risk.

On NextDecade, I don't want to spend a ton of time, because we want to move onto some of these other companies. But, where are they differentiated relative to Tellurian and Cheniere? How do they maybe stand apart in this story?

Hall: NextDecade's taking a little bit different approach. What they're looking to try to do is they're trying to help oil producers that are producing in the Permian, the Haynesville, and the Eagle Ford shale plays in Texas that are producing substantial amounts of associated gas, but they don't have a market to take it to, they're not tied into any infrastructure that can take it. So, NextDecade is looking to take advantage of that massive glut of associated gas. It's possible that, if NextDecade is able to play this right, they could be able to get associated gas, help producers that are spending money to flare this gas and getting zero economic benefit from it, and it could help them tap into a really low-cost natural gas source from a place that doesn't really have any infrastructure to get that gas out right now. So, that's their big play that they're doing a little bit different, is that they're trying to build the pipelines to connect them to the plays. That's a little bit different than what Tellurian is trying to do, they're just trying to get tied into the gas infrastructure, and what Cheniere has done, with kind of the same thing. NextDecade is looking to operate out of Texas. Tellurian is going to be in Louisiana, as Cheniere is today.

That's a little bit of the differences. Their approach is a little bit different in how they're trying to source the gas.

Sciple: Yeah. This is one of those spaces where geography really does matter. Being closer to the source of supply that you're trying to service really is important.

I want to talk a little bit, now, about some of the picks and shovels that go into this space. We've mentioned the billions and billions of dollars that need to be spent by these pure-play exporters just to build up these liquefaction facilities and to get the infrastructure ready to turn the machine on and start liquefying this natural gas. One of the companies that's really going to supply a lot of those guts to these projects is Chart Industries. You've talked about them in the past on the show. For folks who might not be familiar with them, can you give us a high-level overview of what they do?

Hall: Yeah, absolutely. Anybody that's read any of my articles or heard me bloviate about Chart Industries will know that I absolutely love the company. Essentially, what they do is, they manufacture cryogenic gas-processing and storage equipment. Think about liquid oxygen, think about liquid carbon dioxide, you think about liquefied natural gas.

Sciple: Stuff that needs to be really cold.

Hall: Exactly, stuff that needs to be really cold. So, whether you need to make that stuff cold -- the liquefaction equipment that these big LNG export facilities will use to turn gas into liquefied natural gas -- or if you're talking about biological sciences, where they're using liquid oxygen for different things. There are lots of these applications. Gas-processing companies. There's a lot of industrial gas companies. There are lots of different various and sundry applications. Food service, cannabis. So, producing CBD oil and that kind of stuff is a big growth market.

But really, the lion's share of Chart's opportunity is tied to liquefied natural gas. Whether you're talking about these big $10 billion to $30 billion liquefaction and export facilities, or you're talking about what happens on the other end, where the gas gets exported to, and then you have the country that's importing that gas, they need to take the LNG, and then they gasify it, and they put it in their pipeline grid to get it to wherever it needs to be for their utilities or for local use for people's stoves and ovens in their homes or whatever. So, this is a company that has strong potential on both ends of the LNG supply and transportation business.

Another interesting thing that Chart has an interest in now is on the pipelining aspect, the equipment to help move the gas through the pipelines in the compression. So there are lots of different little pieces of the business that Chart is attached to. They're also a big player in natural gas for transportation. You think about a big, heavy-duty tractor-trailer, a class-A tractor that uses liquefied natural gas. Chart makes the fuel systems, like the tanks, that these guys use. The big tanks, like at a gas station that has LNG, they make the tanks for that. So, there's lots of these various and sundry pieces of the LNG value chain, I guess you could say, that Chart plays a role in.

Sciple: Yeah. This is one of those instances where, you had a company -- you mentioned their industrial gas business, their pharmaceutical or medical type businesses -- this is one of those examples of a business that already had some operations in place. And now, there's this huge macroeconomic trend, and they get to ride this way they're well-positioned for, which really creates a big opportunity for them to grow in a significant way.

Hall: Yeah. It's pretty tremendous. If you think about what the opportunity is for the business, this is a company that's grown its earnings substantially over the past couple of years. They reported earnings at the end of October. They did some downward revisions for their guidance for the rest of this year and for all of next year. But here's the thing. I think if you look at the revisions, for next year, the company is still calling for like $6.15 per share in earnings. Just for comparison, the company expects to earn about $2.80 a share this year. So, we're looking at, next year, more than doubling its earnings potentially, based on its recently revised downward guidance. And that's just 2020. If you think about 2021 through 2025, next year is not expected to be the peak of expansion for bringing these facilities online. For example, Tellurian and NextDecade, two of the bigger players, their facilities aren't going to be in operation until 2023. So, there's still multiple years where just these two are going to be investing. I think Cheniere's identified something like two dozen of these large-scale LNG facilities that it's in the running for that are going to be built over the next three or four years. So, there is a tremendous amount upside for a company that's already grown its earnings to continue growing its earnings over the next four or five years.

Sciple: Absolutely. Jason, I want to move on and talk a little bit more about less pure-play opportunities when it comes to the LNG space. First off, let's talk about these major integrated oil companies or integrated hydrocarbon companies. When you look at those major players, which ones have the most exposure to LNG? And, if you wanted to get exposure to LNG, which ones would you pay attention to?

Hall: Of the integrated majors, the one that has consistently been my favorite is Shell. This goes back to Shell's acquisition of BG Group. I don't know, what's it been now? About five years ago, I guess. At the time, BG Group was the largest natural gas major in the world, in terms of the portion of its business. Shale has really made natural gas a big part of its future. So, in terms of natural gas supply, it's a big player in LNG as well. I think the thing that I like about it is, it's a combination of two things. If you're going to invest in one of these integrated majors, you don't want to invest in it just because of something like LNG. You want the rest of its business to be high quality so that, if there are other parts of the oil-and-gas value chain that aren't doing well, they don't wash out any of the potential upside that you might have from something like natural gas or LNG. So, the thing I like about Shell is that management's done an incredible job of deleveraging the balance sheet over the past few years. They're going to continue to do that. They've lowered their operating costs. They've done a really good job of improving their cost of supply. They're producing oil and gas cheaper, so they're able to realize more cash flows, more profit on every unit of oil or gas they produce and then sell. Shell has pretty good refining operations. It has a decent midstream business. And then, because it has prioritized natural gas and LNG, it's able to leverage its global footprint to really monetize those things.

So I think if I were going to pick one major to invest in, looking to benefit from natural gas and LNG, I would take Shell. Even over Chevron. Chevron is really well-known for their Gorgon project in Australia. They have the Wheatstone project or something. I think that's the name. They have a lot of gas going on. But I just think, overall, Shell is a higher quality business than Chevron, and that's going to mean that its ability to leverage the natural gas and LNG opportunity makes it the major that I would probably pick.

Sciple: Sure. And then, last two things I want to mention right quick. When it comes to exposure to LNG, we have Kinder Morgan, which has their Elba Island facility in Georgia for LNG export, as well as Dominion Energy. You don't think of a utility as having much exposure here, but they do have an export facility off the Chesapeake Bay in Maryland, just loaded this past week their hundredth LNG export ship. When you look at these two, anything that excites you about them when it comes to their LNG opportunity?

Hall: Let's put these all in buckets. If you're willing to take on risk, the most risk of permanent loss of capital, you look at the LNG exporters, especially the two smaller guys, the newer ones. If you're looking for some growth potential, and you're still willing to take on some risk, but you know you can get a good, predictable dividend, that's where Shell comes in. Now, if you really want to manage and have the baseline of the best predictability of the business that you can, I think that's where Kinder Morgan and Dominion come in. They have their predictable revenue streams that are relatively untied to commodity prices. They sell a service. They're a toll booth service for moving gas, or supplying energy. They're also a little more protected against recession. So you don't have all of those levers that can cause you to lose money. You might not necessarily realize the best capital returns, but you're going to get the most predictable, highest-quality, protected investment, and you do have some upside that's pointed at where natural gas and where energy demand is going around the world. If that makes sense, that's where I look at those.

I like Kinder Morgan and Dominion Energy both. I think, if I were going to pick between the two, I would probably pick Dominion Energy. Let's just say there are some scars that Kinder Morgan put on my soul a few years ago, and I still haven't gotten over them.

Sciple: [laughs] We've all been there, Jason. For our listeners, to Jason's point, I think there's a lot of opportunities in this LNG space, whether you want to swing for a home run with these pure-play major product exporters like Cheniere or Tellurian, or whether you just want some exposure to what you know is this massive, growing trend through a Dominion or even through a Shell, there is going to be a lot of opportunities for investors to benefit as this market grows over time, and just in general as we across the world want to shift our grid away from dirty coal, more toward clean-burning natural gas -- particularly, as we mentioned off the top of the show, how natural gas can really play nice with these renewables coming down the line.

Jason, going away, for investors that want to get involved in this space and want to invest and pay attention going forward, what should they really pay attention to, to monitor their investment and make sure that it's moving along nicely, and that the thesis is still intact over time?

Hall: If I was on the risk-averse side -- I'm decidedly not, so allow me to be a little hypocritical here -- I would probably invest in Dominion Energy. If you really want to manage your risk, commodity prices are the bane of your investing existence. You're never going to time your way right, and prices can stay much lower longer than you can stay liquid, as they say. So, I would probably say Dominion Energy if you're really about protecting your risk of capital losses.

Now, if you're looking for a home run, I'm going to tell you what I've done and why. I've invested in both NextDecade and Tellurian, and I own a relatively similar amount of both. It's a small position at this point because, to quote an anonymous member of The Motley Fool message boards, these are the kind of businesses that, if they do well, you won't really need a lot; but if they don't do well, you won't really want a lot. So I limit my losses by reducing my exposure at this point. And over time, I'm going to add to both. I'm going to buy more of both as they reach milestones. For example, they start to move forward with breaking ground, they start to get more commitments for funding from joint-venture partners. Hitting those milestones is going to inform whether or not I buy more in each of those companies. Managing the risk, again, it's just managing the size of my holding, and not putting more capital into them than I'm willing to lose.

Sciple: Absolutely. Well, thank you, Jason, as always, for coming on the show. For our listeners, if you're not familiar with LNG, I think this is a space definitely to familiarize yourself with. It's going to grow over time, and I think it's a significant opportunity for folks going forward.

Jason, thanks for coming on the show as always.

Hall: Always fun, Nick, always fun. Let's just stay on and do another show, what do you say?

Sciple: [laughs] We'll see. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan for his work behind the glass. For Jason Hall, I'm Nick Sciple, thanks for listening, and Fool on!