On December 5, Royal Dutch Shell (NYSE:RDS-B) announced that it would cancel plans for a $20 billion gas-to-liquids plant in Louisiana. The plant would have turned natural gas into jet fuel, diesel, and other liquids at a rate of 140,000 barrels a day.
Here are some implications of the project's cancellation.
Less demand for Louisiana natural gas
The gas-to-liquids plant would have created substantial long-term demand for natural gas in Louisiana.
The project cancellation means less local natural gas demand, which is a negative for natural gas producers operating in Haynesville Shale such as EXCO Resources (NYSE:XCO) .
Win for Sasol
After Royal Dutch Shell's announcement, Sasol (NYSE:SSL) reiterated that it will continue constructing its $14 billion gas-to-liquids Louisiana plant.
Royal Dutch Shell's cancellation is a win for Sasol because Sasol's natural gas inputs will be cheaper. The company may also have better leverage in negotiations with Louisiana over permits and taxes.
Not a loss for Royal Dutch Shell
The cancellation of the project isn't necessarily a loss for Royal Dutch Shell. The company hasn't actually started the construction of the project yet, so canceling the project will not result in large write-offs.
Royal Dutch Shell had a bad taste of cost overruns with gas-to-liquids projects. In 2011, it completed a $19 billion gas-to-liquids facility in Qatar which ran significantly over budget. Royal Dutch Shell produced and owned the gas in Qatar so it could predict the cost of gas price in the future. The company would not have owned the natural gas it needed for the Louisiana gas-to-liquids project. The combination of price uncertainty over natural gas inputs and concern over potential cost over-runs probably led Royal Dutch Shell to cancel the $20 billion project. Not investing in a lower return on capital project shows discipline and may lead to higher return on capital employed in the long term.
The bottom line
Royal Dutch Shell has a good grasp of where the prices of oil and gas will be in the future. Oil and gas, after all, is its business. Typically the start of massive capital projects is a good tell of the future because the companies that invest in them need to be very sure of their profitability.
According to Sasol CEO David Constable in an interview, the price of oil needs to be at least 16 times more than the price of 1 mmBTU of natural gas in order for a gas-to-liquids facility to be economical.
Jay Yao has no position in any stocks mentioned. The Motley Fool recommends Sasol. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.