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The U.S. Department of Energy has recently approved a large facility in Texas which will be utilised to export natural gas. Worth $10 billion, the project paves the way for the U.S. to emerge as a major exporter of energy resources in global markets.
The facility in Texas called Freeport LNG is being supported by a group of private investors, which includes the likes of ConocoPhillips (COP - Analyst Report). The project has inked initial contracts with a 20-year horizon with Chubu Electric Power Company, Osaka Gas Co Ltd and BP plc (BP - Analyst Report). The first two are prominent utilities from Japan and also have a stake in the project.
A Paradigm Shift
Originally, such terminals were built for the import of natural gas. It was believed at the time that domestic demand for natural gas would rise significantly. At the same time, it was economically unviable to exploit indigenous natural gas reserves even five years ago.
However, new technological processes have changed the situation completely. Horizontal drilling and hydraulic fracturing has resulted in a significant increase in natural gas production. In fact, the U.S. is now the world’s largest producer of natural gas.
The Obama administration has welcomed these developments and awarded conditional authorization to the Texas-based project. Such approval is required for countries which do not have Free Trade Agreements (FTA) with the U.S. This includes several key European and Asian trading partners.
In the past, a similar facility in Sabine Pass, Louisiana owned by Cheniere Energy, Inc. (LNG - Snapshot Report) has received approval. In this case, however, exports will be made to nations who have free trade agreements with the U.S. The issue is now of particular importance because the Freeport LNG decision may clear the way for the other 19 applications for gas exports to countries without FTAs with the U.S.
Pros and Cons
Freeport LNG was approved after determining whether the projects benefits exceeded the possible negatives for the U.S. economy. Those in favour or natural gas exports believe that these exports will have several beneficial effects. Firstly, it will improve the nation’s trade balance. Secondly, it will promote the adoption of natural gas which is a more environment-friendly energy resource.
However, the policy’s opponents are of the view that this will result in a rise in domestic prices. This would have a detrimental effect on sectors such as the chemical industry as well as consumers who have enjoyed the advantages of low natural gas prices.
Among these is The Dow Chemical Company (DOW - Analyst Report) which has voiced its opposition to gas exports on several occasions. The company has said that U.S. natural gas reserves would be best used internally than through exports.
Another vocal opponent of natural gas exports is chairman of the Senate Energy Committee Ron Wyden. Both Dow and Senator Wyden have said they supported the Freeport LNG decision because the energy department has said they would approve such projects on a case to case basis.
The decision to allow natural gas exports will benefit companies from the oil and natural gas sector. This is because a higher level of exports will increase domestic prices in the U.S. Of course, exports will also reduce the price of natural gas across nations. Therefore, the viability of such exports will depend on the quantum of the price differential.
We believe two companies are good picks given current policy changes and both hold good Zacks Rank. First up is Texas-based Sandridge Mississippian Trust II (SDR - Snapshot Report). It holds a Zacks Rank #1 (Strong Buy) and has expected earnings growth of 5.33%. The forward price-to-earnings Ratios (P/E) for the current financial year (F1) is 5.82.
Another good choice is Chesapeake Energy Corp (CHK - Analyst Report), the second largest producer of natural gas in the country. It holds a Zacks Rank #2 (Buy) and has expected earnings growth of 28.83%. Chesapeake has a P/E (F1) of 14.47.
The demand for energy across the world continues to increase every year. If U.S. companies continue to be price competitive, there is no reason why they cannot dominate the natural gas segment in the years to come.