U.S. LNG offers long-term investment returns

Good things come to those who wait

U.S. LNG offers long-term investment returns At just over 50 years old, the liquefied natural gas (LNG) industry has matured into a significant player in the global energy market upheaval. LNG trade has quadrupled over the past two decades and is poised to double in the next two. Propelled by U.S. activity, 2018 registered the highest global year-over-year growth in gas production at a rate of 5.3%, twice the historical record. Long-term patience can pay off well for investors.

LNG is expected to grow at a much faster rate than natural gas overall because of its inherent flexibility compared with delivery by pipeline, given the great distances between supply centers and demand centers. The United States is a major — currently the major — global LNG player. At least half the expected growth in supply in upcoming years will come from this country, much of it from Texas and Louisiana. U.S. booming natural gas production will continue to contribute to placement as the world’s largest exporter of LNG. Investing can be a wise choice for those who can wait out a lengthy lead time from concept to shipment, with the regulatory approval process, multiple logistics and tax considerations along the way.

Supply, demand and pricing Supply and supplier shifts Most countries lag behind the United States in extraction capabilities and infrastructure. New technologies and advancement in the extraction method used by U.S. oil and gas companies put the United States ahead of other countries. For example, China is believed to have sizable gas reserves, but the lifting cost is high because of accessibility. And Russian gas production already suffers from higher lifting costs due to inefficiencies. About 60% of global gas supply growth through 2035 is expected to be driven primarily by the United States. The U.S. shale gas revolution was a momentous shift that resulted in a significantly lower cost of extraction of natural gas. It led to discoveries and enhanced production in U.S. centers in Texas, Louisiana, New Mexico and several northeastern states.

Of projects in the global pipeline for final investment decision (FID) approval in 2019, about half are in the United States. Each U.S. project is bigger than any of those overseas. In the 12 months between mid-2018 and mid-2019, eight new U.S. projects obtained FID and will begin delivery in three or four years. Total production of 250 million tons per annum (mtpa) is expected from these projects and others from outside of our borders anticipated to receive FID before the end of 2019.

Demand increases The demand side is primarily the Asian market. China, Japan, South Korea are the largest importers, with Japan receiving about 90% of its natural gas through LNG. Growth is expected to continue there and to rise in the Middle East, Europe and India.

A great deal of demand comes from China, which in 2018 signed an environmentally driven “blue sky” bill, the Three-Year Action Plan, to reduce the burning of coal. As a result, natural gas consumption is increasing by about 18% year over year for the initial two years. There will be a two-year extension, and the policy will likely continue after that. An 18% YOY increase in the second-largest consumption market adds up to significant demand over time.

Pricing With increased supply will come decreased prices. Between early 2018 and late 2019, global LNG infrastructure production rose about 15% or 80 mtpa. Assuming pipeline projects receive FIDs in 2019 and shipment-readiness by early 2024, capacity will increase by 25%. This will significantly surpass global demand, driving prices down.

Ramp-up in regasification Liquefaction is the technology that makes LNG such a prized commodity. Cooling the gas to the liquid state compresses the volume by 600%. Storing and shipping of LNG is, accordingly, much less expensive than gas in its natural state. For consumption, LNG must be regasified.

You can’t push more through the line than what can be regasified on the receiving end. By early 2019, global regasification capacity was at 824 mtpa and rising, with an additional 130 mtpa capacity under construction. This included new markets in such areas as Bahrain, the Philippines, Kaliningrad and Ghana; 36 mtpa — much of it in India and China — is planned to go online before the end of 2019. The single largest project was in Kuwait, with 11 mtpa anticipated for 2021. Two terminals added in new markets — Panama and Bangladesh — brought the number to 362.

Getting up to speed across the entire production process will determine success over the next five to 10 years.

Financing for the long haul A 10-year process A new LNG facility requires significant capital investments — typically $5B to $15B. And the stretch of time between concept and receipts from shipment is about 10 years.

U.S. LNG offers long-term investment returns

Concept of operational perspective and financial performance The founders with the LNG concept determine the investment needed by creating a front-end engineering design, the business plan. It includes the facility location, size and layout; and the amount of gas available for liquefying every year. Founders work with equity partners who see a long-term return on their investment and certainty as each step is achieved. In one CEO’s experience, it’s easier to get the billions for construction than to get that first $10M for front-end engineering design.

FERC application and approval The equity partners submit an application to the Federal Energy Regulatory Commission, laying out the plan and the process, the intended buyers and which ones are in commitment discussions. Offtake agreements are usually required to prove investment is complete. In an offtake agreement, a buyer commits to a long-term purchase; for example, Japanese companies tend to sign a 20-year offtake agreement. The contract is taken to the bank, which gives final investment approval. The FERC approval process typically takes 18 months to two years.

Some companies have made it known they are considering an offshore liquefaction facility that doesn’t require the long approval process — cutting out the application effort and reducing the overall project building span.

Pipelines and trains Building or contracting must be carried out for the numerous components — the liquefaction facility, holding tanks to keep the liquid gas cold, trains for transporting it, port terminals and possibly ships, and regasification.

Investors It’s a matter of time and who can get there earlier, given that ultimately the supply and demand will meet. The table lists the main types of investors interested in a long-term relationship.

U.S. LNG offers long-term investment returns

Texas and Louisiana considerations Being proactive is key to maximizing the opportunities. Understanding tax opportunities, liabilities and credits shouldn’t be put off until the construction process. While it’s wise to be informed about tax-related costs of doing business in any state, it’s particularly advisable to be aware of unique situations in Texas and Louisiana, where much of U.S. LNG operation takes place.

For example, the local rate in Texas is only up to 2%. That seems an easy win, considering that most LNG facilities aren’t in metropolitan areas. But in Texas, the local rate is based on the location of the supplier, not the plant. If products, supplies and machinery are purchased from suppliers in, say, Houston, the 8.25% metropolitan tax rate applies. The best recourse is a direct pay permit, which relieves the vendor of the tax-charging burden, placing it on the facility owner. A good rate arbitrage, it flips the tax base paradigm from the supplier location to the facility location. Another benefit is a manufacturing exemption, which exempts the local tax and the state 6.25% portion. There are numerous other aspects to be aware of, including nontaxable services such as contracting for rental equipment operators.

Louisiana also has a tiered rate structure, though at 4.45% the state tax rate is much lower than the Texas rate. However, local rates go up to 7%. Unlike in Texas, in Louisiana the tax rate is based on the destination or the plant location. Louisiana offers a direct pay permit but without a rate arbitrage. It is critical to be informed about Louisiana’s concept of movable versus immovable objects. It’s a gray area, but in general, an object is deemed immovable if substantial damage would be incurred upon removal. Large boilers and other types of massive machinery might be assumed to be immovable objects, but the state asserts they’re movable; material and labor are taxed.

U.S. LNG offers long-term investment returns

An economic impact study is essential in either state because for the most part credits and incentives must be pursued before any announcement of the project to the public.

U.S. LNG offers long-term investment returns

Patient, educated investors could receive good things “The LNG sector is going to develop further as companies enter this space,” said Grant Thornton Energy Services National Managing Partner Kevin Schroeder. “We’ll see more liquid markets develop and cross the other service providers in the sector.”

Kyle Reid, Energy Services partner, concurred: “LNG investors must be in tune with global relationships because the global political environment is constantly impacting supply and demand. The long-term commitment is challenged by ever-changing geopolitical relationships between key players. This creates uncertainty and risk.”

Significant returns can be expected by private equity infrastructure funds, which are able to spread their risk among a number of LNG facilities. The risk exists that they all will fail, but the likelihood is great that many will thrive.

For further details and guidance, register to replay the webcast, Opportunities for LNG in Challenging Times.


Kevin SchroederKevin Schroeder
National Managing Partner, Energy
T +1 405 415 3550

Ed FaragEd Farag
Partner, Audit Services
T +1 832 384 7048

Kyle ReidKyle Reid
Partner, Transaction Services, Energy
T +1 832 384 7050

Pat McCowanPat McCown
Partner, State and Local Tax Services
T +1 832 476 3619