LNG - Cheniere Energy: Placed On Hold Due To Projected Decline In Selling Prices

2023-12-18 16:13:09 ET

Summary

• Europe's dependence on LNG and expected increase in gas demand from Asia ensure the need for LNG.
• Europe faces the risk of winter instability and market tensions despite full storage facilities.
• Cheniere Energy's Q3 2023 financial results show a decrease in average selling prices, leading to a downgrade in rating to HOLD.

Investment thesis

Europe's significant dependence on LNG, despite measures to reduce gas demand, as well as the expected increase in gas demand from Asia, guarantee the need for LNG in our view. Of the nearly 6 mt of long-term deliveries made since the beginning of 2023, more than 75% are to loyal customers who clearly value their long-term partnership with Cheniere Energy ( LNG ). In addition, Cheniere Energy recently entered into long-term contracts with BASF and Foran to supply gas to Europe.

We have covered the stock before and do so regularly, so here's the new report covering the company's Q3 2023 financial results, along with the analysis and forecast based on them. The main reason for the downgrade was a decrease in the company's average selling prices due to a lower forecast for the European gas benchmark. Rating is HOLD.

LNG market

Optimism for the upcoming 2023/2024 heating season in the Northern Hemisphere is supported by high gas reserves in strategically important markets such as Asia and Europe. Nevertheless, despite full storage facilities, there is a risk of winter instability and market tensions.

A cold winter could increase natural gas demand in the EU residential and commercial sectors by 30 bcm compared to the 2022/2023 heating season. Given also geopolitical uncertainty, there is a possibility of further reductions in Russian pipeline gas supplies to the EU.

In light of these risks, the gas storage trajectory projections , provided by the International Energy Agency take into account possible significant changes during the upcoming heating season. In the event of a cold winter, and if LNG supplies do not increase compared to the previous heating season, the EU risks having storage facilities less than 30% full of their capacity in March 2024.

To ensure a sustainable gas balance in the 2023/2024 winter season, structural measures need to continue, including reducing gas demand, improving energy efficiency, actively introducing renewables and accelerating the installation of heat pumps.

LNG imports to Europe were lower YoY during Q3 and for the first time in 2 years. Imports decreased by almost 7%, or by 1.8 mt due to:

• Record high filling of storage facilities after the 2022/23 heating season, as we wrote about in the previous report ;
• Reductions in gas consumption due to conservation measures in public buildings, installation of heat pumps, fuel switching in rural households, which of course will not be reversed, and we forecast a further reduction in gas demand in the EU, albeit not as sharp as when these measures were initially introduced;
• Decline in economic activity in a number of European countries. The Manufacturing PMI in the eurozone continues to be below 50 (and consistently below 44 in Q3 2023), indicating a decline in new orders in the industry and, consequently, lower gas demand.

In addition, due to the soft entry into the heating season this year, the first pumping of gas from the storages took place only in the first days of November. At the same time, as of November 12, 2023, the storage facilities reached 99.49%, and by the end of November it had dropped to only 97.5%.

Total LNG imports to Asia in Q3 2023 grew by more than 4%, or 2.7 mt YoY, driven by a rebound in imports to China and India as lower prices and high summer temperatures boosted spot purchases. In fact, imports in the key growth markets of China and India grew 21% and 27% YoY in Q3 2023, respectively.

China has seen an increase in demand for natural gas during the last quarter, mainly driven by a recovery in gas-fired power generation compared to last year. Earlier, drought conditions caused a decline in hydropower generation. Despite the increased demand, gas requests in the industrial sector are recovering at a moderate pace and consumption is still below 2021 levels. Long-term fundamentals remain favorable for the Chinese market and are supported by favorable policy initiatives and large-scale construction of gas infrastructure.

An important aspect of the development of imports to Asia is the availability of regasification terminals, the number of which China and India plan to multiply over the next few years.

It is worth noting that the IEA forecasts that the Asia-Pacific region will account for about 80% of global gas demand growth between 2023 and 2024.

Unit Economics

In Q3 2023, LNG sales totaled 11.3 mt, or 555 trillion BTU. LNG sales under long-term contracts annually accounted for the largest share in the sales structure.

We project LNG sales based on the capacity of two LNG plants, Sabine Pass Liquefaction and Corpus Christi Liquefaction , with 6 and 3 LNG liquefaction production lines, respectively, and based on 100% capacity utilization. Capacity will remain at ~30 million tons and ~15 million tons through 2024. The Corpus Christi Stage 3 expansion project is currently underway and will increase the company's liquefied natural gas capacity by Q1 2025, although possibly even sooner as Cheniere Energy reported a 1-month construction schedule ahead of plan on its Q3 2023 results conference call.

Thus, we expect the company to sell 46.5 mt of LNG (-1% YoY) in 2023 and 39.5 mt of LNG (-3% YoY) in 2024. The YoY decline is driven by over-fulfillment of the capacity utilization plan throughout 2022 and Q1 2023, and we expect 100% utilization quarterly thereafter. It is worth noting that since Cheniere Energy restructured its business to LNG in 2016 (the company was established in 1983 to explore for oil and gas), LNG sales volumes have been growing at a CAGR of 20% annually. In addition, the company produced its 3000th LNG shipment in Q3 2023, becoming the fastest growing LNG producer in history to reach this milestone. Nevertheless, we no longer view the company as a growth company and categorize it as a cyclical company, as such LNG capacity expansion is no longer expected in the coming years and the company's revenues will vary depending on the prices of various contracts (long-term, short-term and third-party) with uninterrupted operation of LNG terminals.

As for gas sales prices under various contracts, we rely on international benchmarks - Henry Hub and TTF - in our forecast. In Q3 2023, the TTF benchmark covered a spectrum from $300/tcm to $500/tcm, influenced by, among others:

• hot weather in the summer, which increased electricity consumption for air conditioning and reduced wind power generation;
• news of possible strikes at LNG plants in Australia (which accounts for about 10% of global LNG production), which subsequently began part way through September 14-22, 2023 at Chevron (CVX) plants alone (which produce 5% of global LNG production);
• reduced exports from Norway due to repairs.

Although gas storage facilities in Europe had a high level of occupancy at the end of the 2022/2023 heating season, on the way to the new heating season, gas prices in Europe reacted unusually sharply to the news.

Given the high level of gas storage occupancy, lower gas demand, as well as events that have already occurred after Q3 (gas leaks at the Baltic connector pipeline in the Baltic Sea, threat of renewed strikes in Australia, armed conflict in Israel), we have revised downwards our forecast for TTF gas prices from an average of $479/tcm to $462/tcm for 2023 and from $751/tcm to $503/tcm for 2024.

For Q3 2023, the average LNG price across all Cheniere Energy segments was $369 per ton versus our forecast of $409 per ton (down 10%), despite price increases in both benchmarks QoQ.

We project the LNG price under long-term contracts through the sum of the Henry Hub price in $/kcm and the spread to the benchmark, which represents Cheniere Energy's markup to the HH price. Previously, we expected a wide spread between the realized price and the Henry Hub price to persist over the coming year amid strong LNG demand and capacity constraints. However, we now expect an earlier narrowing of the spread to historical averages due to:

• lower gas demand in Europe due to the measures taken to reduce gas consumption, which proved to be effective in H1 2023;
• plans to increase regasification terminals in Asia, a market where LNG demand is set to grow. Increasing the availability of LNG to Asia will help meet growing demand without risking the market and without the risk of gas price volatility.

Thus, with the HH forecast essentially unchanged and the spread decreasing from $139 to $126 in 2023 and from $126 to $111 in 2024, we have revised downwards the LNG price forecast for long-term contracts in 2023 from $326/ton to $313/ton and from $340/ton to $321/ton in 2024.

Due to the lower TTF forecast, we have also revised downwards our short-term LNG price forecast from $1,239/ton to $1,033/ton for 2023 and from $1,694/ton to $894/ton for 2024.

Therefore, we have revised our forecast for the average LNG sales price across all Cheniere Energy segments from $460/ton to $430/ton for 2023 and from $494/ton to $398/ton for 2024.

COGS model

The company's gross costs are quite volatile, ranging from 52% to 152% of revenue (in the case of derivatives trading losses), and it manages to keep the spread between selling price and costs at an average of about $200/kcm.

We remain committed to the logic that net COGS per tonne dynamics are linked to the Henry Hub gas price. We expect that this approach gives a closer approximation of the cost dynamics to domestic market prices.

We have revised upwards our gross cost per tonne forecast from an average of $201 to $215 by the end of 2024 on the back of a slight increase in U.S. natural gas prices. The production costs we use include an adjustment for derivatives trading.

We have revised our EBITDA forecast downwards from $10,262 mln (-11% YoY) to $8,770 mln (-24% YoY) for 2023 and from $10,071 mln (-2% YoY) to $6,261 mln (-29% YoY) for 2024 due to:

• Decrease in average selling prices across all segments from $524 to $460 per tonne for 2023 and from $540 to $494 per tonne for 2024;
• Increase in production cost per tonne forecast through the end of 2024.

Valuation

We have revised our target stock price downwards from $237 to $198 due to:

• Lower EBITDA forecast for 2023-2024;
• Upward revision of our target EV/EBITDA multiple from 7.6x to 10.7x. Due to the lowered outlook for gas prices in Europe and lower spread to Henry Hub benchmark, we lower our forecast for average realized LNG prices across all segments, assuming that the world returns to lower gas prices after several quarters of higher prices amid high LNG demand with limited supply. Thus, the current elevated multiplier for LNG reflects the low LNG cost cycle;
• Shift in the FTM estimation period.

Given the new assumptions, we assign HOLD rating to the stock.

Conclusion

We will continue to monitor the 2023/24 heating season and how fast the demand for gas in Asia will grow. But for now, with the company's future sales volumes comparable to the current ones and the projected selling price reduced, we assign a HOLD status to the shares.

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