A Look At The Energy Of The Future: Natural Gas
America’s natural gas industry can make you rich.
If you’ve been sleeping under a rock for the past few years or you’ve thrown your DRH missives to the wayside, allow me to reiterate this important thesis.
Natural gas and associated “wet” byproducts like propane, butane and ethane, are flowing rapidly from America’s shale formations. It’s a bonanza of cheap energy! It’s also set to make a few industries insanely profitable…
Before we get started on the latest way to play this trend, take a second to dig out that dusty heap of electricity bills you keep in the closet. (If you’re a frugalisto like me you’ve likely got every bill dating back to the time that you bought your house.)
Now, compare the “rate” you were charged on your most recent bill to that of last year or the year before. Regardless of how much electricity or natural gas you use, that “rate” is likely lower by say, 10-30% – mine for instance is nearly 30% lower than just a few years ago.
That savings is the trickle-down effect of America’s shale boom. For us, it’s a bill changer. For the industry and our economy it’s a game changer.
Today there’s even more good news for the natural gas crowd. It comes in the form of a big story that just hit the newswires yesterday…
BioFuel is Dead – Look to Nat Gas
According to a report from Bloomberg, one of the pioneers of the biofuel industry has turned his back on the technology and, instead, moved towards natural gas opportunities.
Alan Shaw, as the report explains, was the former CEO of Codexis, the first U.S.-traded biofuel company. Today, Shaw has pulled back the curtain on uneconomic biofuels – calling the industry a “nightmare” and admits biomass is ultimately the “wrong” feedstock.
Today Shaw is focused on a similar fuel venture. Only instead of using corn, wood or switch grass, he’s looking towards natural gas.
Taking a step back, this is the most refreshing and “real” report I’ve seen since the Solyndra debacle. (Solyndra if you don’t remember is the failed, Obama-darling, solar company. Turns out even a $535 million government loan couldn’t make this uneconomic venture work.)
Much like the Solyndra reveal, this week’s report is finally shedding some light on the oft-praised biofuel craze. Although inherently good natured, today’s biofuel industry is far from economic.
Truly, I’m not saying that I don’t like the idea of renewables. Fact is, I do. You’d have to admit, though, that a lot of the folks that jumped onboard the biofuel wagon were too focused on the pie in the sky to see the crumbling economic foundation.
Today the game has changed substantially. If you consider the biofuel industry as Goliath, natural gas is David. Abundant, cheap, clean-burning natural gas is here to stay – for decades to come.
It’s a new economic reality – and now’s the time to make sure you know who the winners will be…
The Next Natural Gas Fueled Boom
Cheap natural gas is opening the door for some industries to cash in. Today I want to talk about the coming growth and profit opportunity in the chemical industry. As you can see from the chart below, business is booming…
The key to this chemical boom has to do with America’s shale gas boom — in particular natural gas liquids (NGLs.) These are the “wet” byproducts that flow out of the shale wells – indeed much of what’s being drilled today is loaded with the em.
NGLs include propane, butane and ethane. You’re likely familiar with the first two – used mainly as fuel and heat – but today we’re going to talk about the third, and potentially most profitable, ethane.
In short, ethane is a feedstock for ethylene, a highly used chemical. The primary end use according to Shell “is in film applications for packaging, carrier bags and trash liners… injection moulding, pipe extrusion, wire and cable sheathing and insulation, as well as extrusion coating of paper and cardboard.”
That’s all well and good – but here’s what you need to know…
As of January 2013, the U.S. is able to produce ethylene for about 6-10 cents a pound – on the low end that’s a 45% decrease in the cost from July 2012. Important to note, that low cost of production puts the U.S. close to places like the Middle East – the cost there is anywhere from 3-6 cents per pound.
But here’s the kicker, right now on the U.S. spot market the stuff sells anywhere from 40-55 cents. If you’re doing you math at home that’s a HUGE mark-up (margins are anywhere from 35 cents to 45 cents per pound), and ethylene makers are loving it.
Take the #2 North American producer, LyondellBasell (LYB), for instance. Their current yearly capacity is 9.8 billion pounds per year. You do the math.
Okay, I’ll do the math. 9.8 billion times, say 40 cents, puts gross revenue near $4B a year.
Sure, LyondellBasell is a $47B market cap company – but we’re talking about a very big chunk of change. Accordingly, the share price is up some 36% year over year – and they pay a 2.7% dividend to boot.
Another thing I like about LYB is that they’re not currently interested in the race to build a new ethane cracker plant (the plant that converts ethane to ethylene.) Instead of a new build, LYB is planning on increasing output to help squeeze as much revenue out of this shale boom as they can – all at a minimal cost.
If you’re wondering, the #1 producer of ethylene in the U.S. is Dow Chemical (DOW.) Dow hasn’t seen the year over year rise that LyondellBasell has, but the company still has a lot of promise in the ethylene business.
The other name that I’ll add to the basket of quality chemical plays is Phillips 66 (PSX). I won’t call them a pure-play, but they are close to the realm of what we’re going after here. Phillips 66 is a midstream player that also has a booming chemical business.
In particular, the company owns a 50% share of Chevron Phillips Chemical Company, a top-10 global producer of ethylene.
In short, U.S. companies that produce ethylene from ethane will stand to do very well. They’ve got decades of supply and the demand chain is already there.
There is, however, one extra wild card that could work in investors favor…
The Government Discount?
Last fall an obscure piece of news ran across your editor’s desk…
“The IRS hands the US petrochemical industry a favorable ruling” the headline from Platts said.
The IRS ruling, according to Platts, “has opened the doors for US chemical producers to structure olefins [ethylene and propylene] business units as master limited partnerships, which generally are exempt from corporate taxes and have a relatively low cost of capital.”
So you see, much like pipeline companies can spin off assets into Master Limited Partnerships (a tax-sheltered investment class that usually pay high dividends), now chemical companies can do the same.
Time will tell if we’ll see any spinoffs in the chemical space, but here we are six months past the IRS ruling and I’m sure more than a few companies have been reviewing the idea.
Indeed, this ruling makes holding LyondellBasell, Dow or Phillips 66 even more potentially lucrative. An announcement from any company would surely add a nice bump to the share price – and give you the inside track on any MLP/spinoff action.
Stay focused on this booming chemical industry. The names listed above could be spinning cash for years to come.
Keep your boots muddy,
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