Market Buzz - Prudent Thoughts on Investing in A Coming West Coast LNG Boom

Quietly this past week, Canadian Natural Resources Minister announced the Government of Canada’s approval of four long-term liquefied natural gas (LNG) export licences for Pacific NorthWest LNG, Prince Rupert LNG, WCC LNG and Woodfibre LNG.

The four export licenses combined will allow for the export of up to 73.4 million tons of LNG per year.

Along with the announcement Minister Rickford stated that Canada (the West Coast specifically) is well positioned to help meet the growing market demands for liquified natural gas. LNG from Canada’s West Coast can get to Asian markets in less than two weeks compared with the month it takes a tanker to leave from export terminals in the Gulf of Mexico.

“World energy demand is on the rise, and Canada has the unprecedented energy supply to meet that demand,” he said in a statement.

These are hardly revelations but support a theme we have been covering for quite some time now and have already benefitted from the anticipation on this coming boom in a number of the oil & gas service companies we have recommended over the past year. Having said this, the true benefits in terms of hard cash flow remain likely more than a year in the future. But they may last for decades.

At this stage, we are likely only in the first inning. But, we would not be surprised to see some hiccups along the way. These will provide long-term opportunities for investment in solid companies. At this stage, our bias is towards service energy and infrastructure service stocks with existing strong businesses which are positioned to benefit from a B.C. LNG boom if and when it occurs but can stand on their own two feet without it. We already have 2-4 of these types of companies in active coverage with built in gains that are positioned for potential explosive growth if the boom does in fact take place.

Quick LNG Related Stats

• Canada is the fifth-largest producer of natural gas in the world and has up to 37 trillion cubic metres of marketable natural gas resources, enough to meet our current production for over 250 years.
• The International Energy Agency’s 2013 World Energy Outlook predicts world energy demand will increase by 33% by 2035. The rapidly rising economies of China, India and the Middle East will drive growth, commanding more than 58% of the rise in global energy demand. India’s energy needs alone will double over this period.
• The Conference Board of Canada estimates that potential growth in British Columbia’s natural gas sector alone could attract $180 billion in new investment and create 54,000 jobs per year between 2012 and 2035.
• Each Canadian LNG facility will be subject to a thorough environmental assessment and regulatory review to ensure it can be developed safely.

On Wednesday, a report authored by RBC Dominion Securities Inc. singled out Pacific NorthWest LNG (led by Malaysia's state-owned Petronas) as the B.C. project that has been taking large strides toward reaching the goal of supplying energy-thirsty customers in Asia.

“Pacific NorthWest LNG has established a high degree of momentum, with a final investment decision expected by the end of 2014,” according to the global study by RBC’s energy team headed by Greg Pardy and Kurt Hallead.

Pacific NorthWest LNG, one of 14 projects proposed for British Columbia’s coast, has grabbed headlines of late as the Malaysian government adds new Asian partners for the joint venture.

Pacific NorthWest LNG estimates that almost $36-billion will need to be spent in order to make its export plan a reality in late 2018. The massive budget includes nearly $11-billion for the export plant to be built at Lelu Island, near Prince Rupert.

The West Coast LNG boom is by no means a slam dunk at this stage as global competition, environmental issues, funding and the tax regime are amongst a number of issues still to play out.

Start with the B.C. government’s document on its proposed new tax regime. To date, the information provided publicly consists of a short two-page backgrounder tabled just over a month ago along with the provincial budget.

The short document indicated a two-tier income tax on LNG production, with 1.5% to be charged on net proceeds up front and a second rate of “up to 7%” scheduled to kick in once the operator’s capital investment has been covered.

Opponents including Jack Mintz, economist at the school of public policy at the University of Calgary, who also happens to be a director of Imperial Oil (a company that has a stake in one of the proposals to develop B.C. LNG) points out that B.C. already taxes natural gas by collecting royalties on the extraction of the resource at the wellhead. But as Mintz notes, the proposed special tax would impose a rather atypical second levy on processing of the resource in liquefied form.

“Applying a special tax on LNG is akin to applying special refining taxes in oil and gas and mining or manufacturing phases in forestry, which has not been pursued by other provinces,” noted Mintz.

While we believe the sitting B.C. government, which has made the development of LNG a priority, will eventually implement a competitive tax regime, the current uncertainty and/or lack of a competitive structure could help serve to derail some of the capital investment that will be necessary to develop a number of the large scale proposed projects. Corporate capital is mobile and will not wait in limbo forever as a country dithers in red tape for environmental work, special tax regimes and other special interest groups to have their pound of flesh. Eventually, the capital is employed elsewhere.

Additionally, Canada is trailing the United States in the North American LNG export race, RBC cautions. The United States has the advantage because major proposals south of the border are “Brownfield” projects that call for reconfiguring existing import facilities and converting them to process LNG exports. By contrast, Canada is relying on “Greenfield” projects that effectively mean starting from scratch.

RBC also noted that Australia is emerging as an LNG heavyweight, bolstered by seven export projects under construction.

“Australia is set to eclipse Qatar as the largest global supplier of LNG by 2018,” the report said. Australian Greenfield LNG projects, however, have been stung by cost overruns.

Again, we believe it wise to have exposure to the potential LNG boom, but we stress it be done prudently with a bias is towards service energy and infrastructure service stocks with existing strong businesses which are positioned to benefit from a B.C. LNG boom if and when it occurs but can stand on their own two feet without it.

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