MORAM - The natural gas market explained + Investment thesis Maurel & Prom

Sunday 21st May 2023

MORAM Capital

May 21, 2023

∙ Paid

This week, we bring (what we believe there are) two very interesting articles.

The first article serves as a prelude to one of the most challenging investment theses we have presented (and we say this from firsthand experience, as we have been in and out of New Fortress Energy since its IPO in 2019). From an investor's perspective and with great detail, we explain how the natural gas industry works. We emphasize the importance of understanding the different economics of each of its three segments, which allows us to determine which part benefits depending on the situation. Additionally, we discuss eight companies in the industry and identify where we believe the opportunities lie in this market.
The second one (published yesterday) is the first in a series of three special situations in the Oil & Gas industry. It focuses on the investment thesis for Maurel & Prom, where we provide a detailed analysis of the company, deeply examine the short-term catalysts, and compare it with its peers Vaalco, Panoro Energy, BW Energy, and Kosmos Energy.

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1) The natural gas industry explained

Introduction

This is the first time we are writing an article of this nature (sector guide from an investor's perspective - plus the essential technical details), but we believe it will be quite useful, even necessary for those who are not familiar with it before our thesis next week on New Fortress Energy, which is a company present throughout the natural gas value chain. As we were "transferring from Excel to Word" the NFE thesis, we realized the complexity of understanding their business model if someone is not familiar with the sector.

Those who have been following us for some time know that this is one of the sectors where we feel most comfortable and where we have carried out some of our well-known theses (and investments) such as Golar LNG, Cheniere, Kistos, or New Fortress Energy itself in 2020.

In this sector guide, we will discuss the following points:

Arbitrage between markets
The natural gas cycle
Companies involved in each part of the cycle
Basic concepts and units used
Current situation and forecast
The opportunity

Arbitrage between markets

If there's one thing for which this sector is known (beyond what has happened in the last two years), it's the arbitrage between markets. Natural gas is increasingly becoming a commodity; however, it is a much less developed market compared to oil, which leads to the same commodity being traded at very different prices in different parts of the world.

This is particularly evident in what we refer to as energy islands in this article, where natural gas has to be transported by ship from one location to another. Pipeline infrastructures are more developed than maritime transport, which was relatively underdeveloped until a few years ago (the fracking boom in the US from 2010 to 2014 greatly contributed to advancements in this area; the number of LNG carriers has exponentially increased in the last 15 years, currently reaching about 700). As a result, areas near gas-producing countries already have well-established pipeline systems and enjoy better conditions (pipeline transportation being cheaper than maritime transport).

The main LNG exporting countries are Australia, Qatar, and the United States, while the main importers are China, Korea, and Japan. (Russia is also significant, but the majority of its exports are through pipelines.) With this information, we can define what we refer to as energy islands in regions such as North America, the European Union, the United Kingdom, and developed Asia.

These energy islands each have their own reference index, with the most important ones being the Henry Hub (US), TTF (Europe), NBP (UK), and JKM (Japan-Korea).

The Henry Hub (HH) index is the most widely used benchmark for natural gas prices. The HH index is based on natural gas prices at a trading hub in Louisiana and is used as a benchmark for natural gas prices across North America.
In Europe, the Title Transfer Facility (TTF) is a natural gas trading hub in the Netherlands. Meanwhile in the UK the National Balancing Point (NBP) is the index adopted
The JKM is based on prices for LNG delivered to Japan and South Korea and is used as a benchmark for LNG prices across Asia.

It's worth noting that the United States is an exporter of natural gas (particularly since the fracking revolution from 2010 to 2014, as it was previously an importer), while the others (TTF, NBP, JKM) are importers. Traditionally, Europe and the UK had access to cheap gas due to Russia, the world's main producer, providing them with inexpensive gas through land-based infrastructure. However, this changed in 1Q22 with the Ukraine invasion. As a result, over the past decade, the JKM has consistently been more expensive than the TTF, and both have been more expensive than the HH.

To transport natural gas between these energy islands, LNG carriers (LNGCs) are required. The LNGC market is divided between long-term contract carriers and spot carriers. Spot prices depend on the supply and demand of these carriers and are typically higher during the winter in the northern hemisphere due to increased natural gas demand, primarily for heating purposes.

In other regions, Australia is a major exporter, mainly to the JKM market, so they use this index. Africa, particularly the western part, is starting to develop many gas projects by European companies, so they use the TTF index. In South America, mainly Brazil, we will directly address it in the article on $NFE as its international LNG relevance is less significant than the other areas discussed here.

The natural gas cycle

Natural gas is the third most widely used energy source, trailing behind oil and coal (approximately 23% of the world's energy consumption comes from natural gas). Its main uses (gas demand) are for heating, electricity generation, and industrial applications. Additionally, it is used to a lesser extent in transportation.

From our perspective, natural gas is going to be the key energy source during the energy transition in the next 25 years. Fossil fuels cannot be replaced overnight by renewable energy sources because the infrastructure is not yet prepared, and it would require trillions of dollars worldwide (cost estimates vary significantly depending on the source, but for illustrative purposes, around $6 trillion annually until 2050).

However, this does not mean that everything related to the sector will experience tremendous growth throughout this entire period. Each of the three industries within the natural gas cycle has its own supply-demand economics, and there are significant events on the horizon that will affect them in different ways.

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