How do investors play the LNG boom that is still in the early stages in Canada?
Many investors believe the opportunity is far off. After all, most of the projects are still in the application phase—it will be years before they get built and start selling cargos.
But National Bank energy analyst Greg Colman sees profits from LNG coming much sooner—right now, in fact.
He estimates there is $55 billion in capital coming into the Canadian LNG sector over the next few years. . .and the spending spree in western Canada is starting now.
And he laid it all out for investors in his 29-page research report on July 9, "Quantifying the LNG Impact."
In order, he told investors:
- First buy the drillers and the frackers
- Then buy the companies that supply the camps for all the construction and full-time workers
- Then buy the haulers/lifters
Colman's innovative research came from piecing together exactly what happened when similar LNG projects were developed in Australia.
His work points to a startling conclusion: LNG developers generally spend billions before a single survey peg is grounded on a new gas export facility.
To find out more about what's happening, I sat down with Colman to ask exactly how investors can get in on the ground floor of this boom. He outlined his three-stage plan for grabbing a chunk of the profits from the massive ramp-up coming in LNG.
Below are some of the must-hear moments. . .
OGIB: Greg, in your report "Quantifying the LNG Impact," you've studied a somewhat unusual place—Australia—to get an idea of what might happen in Canada as LNG production grows?
GC: Yes, we're trying to point to Australia as an example of somebody that's already done the LNG exporting. So it gives us a rough idea as to the pre-drilling time and the amount of pre-drilling volume you have to have.
OGIB: And you found that drilling activity actually begins long before LNG export facilities are commissioned?
GC: We came to the assumption that 200% of the export capacity has to be available at the time exporting commences. LNG facilities in Australia ranged between 137 and 268% of the export capacity. So we just took a midpoint there and said 200.
OGIB: So assuming you need to have 200% of your capacity already pumping at the time exports commence, how far in advance do you need to start development drilling?
GC: Generally what happened in Australia is you had about 4 to 5 years of time to pre-drill.
OGIB: That's a lot of lead time.
GC: If you wait until the summer before you're turning on your LNG facility to try to get 6 BCF of production drilled, you're going to have to get every drilling rig in North America up into B.C. The cost would be astronomical.
OGIB: In your report, you forecast that LNG-related drilling is going to cost $55 billion over the next several years. How can investors bet on that massive influx of capital into the oil and gas services sector?
GC: I think the biggest near-term opportunity for investors is represented by the frackers, the drillers and the mobile accommodation providers that we typically refer to as the "camps."
OGIB: You've discussed this as a sort of "three-stage" investing approach. What area should investors be looking at right now?
GC: I'm probably a little more biased towards the frackers. Stemming from two things. First, the fact that the frack intensity of gas plays tends to be significantly larger than the frack intensity from oil plays. Number two is that recently those companies have tended to be punished more from a share price perspective than the drillers.
OGIB: You've also mentioned some unique things about cost structures that might benefit frackers.
GC: The frackers have a much more fixed cost structure. This means their margins expand more when activity picks up.
OGIB: Can you explain that a little more? Frackers costs are more fixed than for the drillers?
GC: Yes. The drilling companies have much more variable costs in their structure versus the fracking companies. So as activity levels slow down their costs come down along with the activity level. Meaning you don't get much margin compression.
OGIB: I see. Even when drillers are getting paid less during slow times, they still make similar margins because their costs drop. But that's not true for the frackers?
GC: For the frackers with their largely-fixed costs, as activity levels start to pull back and pricing comes down you get much more margin compression than for drillers. The flip side is that when drilling picks up, fracking margins will expand more than for the drillers.
OGIB: How far away are we from these services companies seeing tangible benefits from the LNG boom?
GC: The huge uplift in demand for services is probably still one-and-a-half to two years out, again assuming these decisions are made to proceed with the facilities. But we are already seeing the initial demand, smaller but still meaningful in the very near term.
"Very near term" is a phrase I like to hear when it comes to profits. Especially in this case, because most of the market is assuming that LNG won't have a material impact for years or even decades to come.
But with all the majors who've signed up for Canadian LNG—Chevron, Apache, Shell, BG, and most recently Malaysian major Petronas announcing it will invest $20 billion to develop its Pacific Northwest LNG project near Prince Rupert—we're talking about a development almost unprecedented in our petroleum sector.
And once these firms start selling North American gas at $4/MMbtu to high-value markets like Japan and Korea at prices up to $15/MMbtu, a lot of profit is going to be made.
If Colman is right (and he makes a very compelling and well-researched argument), this could be one of the single most important events for the oil and gas services sector in the last 25 years.
Just the top six projects (out of 12 now) suggest Canada could ship 13 billion cubic feet of LNG to Asia in 10 years—that's as much as the entire country produces right now!
A $55 billion influx is a huge amount of money. Companies grabbing a piece of this pie are going to eat well.
Oil & Gas Investments Bulletin