LNG: Bury Old Myths, Embrace New Reality
Commodities are rarely associated with explosive consumption growth. While the rise of China challenged this notion, the best days of the super-cycle in materials are clearly behind us. For example, over the past three years the world’s consumption of copper rose just 0.6% per annum, and it is unlikely to expand much beyond this rate. However, there is one commodity which we are excited about for the next 10 years, one for which the super-cycle has only recently announced itself  ̶  liquefied natural gas (LNG). The LNG market has been in the doldrums for some time. Between 2011 and 2016, total global consumption rose by just 17 million tons. But in 2017 alone, demand skyrocketed by nearly twice that amount. The size of the global LNG market stood at 290 million tons last year, and we expect it to double by the end of the next decade. We believe no other major commodity can possibly match this trajectory.

Exhibit 1: Demand for LNG Has Skyrocketed and It Could Continue to Soar

Two major structural shifts are happening at the moment: the globalisation of natural gas – traditionally a local or, at best, regional commodity – and the political will in China and elsewhere in Asia to secure affordable, reliable, and clean energy. Natural gas has long been viewed as the “fuel of choice,” a privilege confined either to producing countries like Russia and the United States, or to the domain of the economically developed, like Europe or Japan. This old-world view is now collapsing. Earlier this year, China became the largest importer of natural gas, overtaking Japan, and it is highly likely that its LNG consumption alone will surpass that of South Korea next year. LNG specifically is becoming the “fuel of necessity,” and the growth from here will be driven by China, other Asia ex-Japan countries, and eventually India. Our recent meetings with policymakers in China reconfirmed this outlook: fostering a healthy environment is being viewed as critical to maintaining social stability, and nurturing gas consumption, as well as finding substitution for low quality, are integral to both.

Exhibit 2: The Increased LNG Demand Will Be a Global Phenomenon

The supply side is shifting as well. Qatar, which accounted for nearly a third of the market in 2016, will likely be temporarily overtaken by Australia next year. The United States, irrelevant on the LNG map until three years ago, could account for one-sixth of global LNG production as soon as 2020. Finally, Russia will challenge all three contenders for the LNG throne, securing at least one-tenth of the market by the middle of the next decade, and a credible chance to become the “next Qatar” in the long run.

Exhibit 3: Russia and the U.S. Could Emerge as Much More Prominent LNG Suppliers

The narrative becomes much more powerful considering that the LNG market may begin tightening in 2020 and could move into deficit early in the next decade. We believe the world will need more liquefied gas than is currently being sanctioned by the energy companies, which underinvested in LNG during the oil price debacle of 2014-2016. The energy companies lack a sufficient quantity of viable projects and are using their cashflow to channel dividends to their still wounded shareholders rather than invest.

Exhibit 4: Within Four Years, Global Demand Could Begin to Exceed Supply

So, the race is on. The question is how to invest in such a powerful and structurally durable theme in an emerging market context? This is where the challenges begin. First, it is hard to find pure exposure outside of the United States. (It can now be found mainly with the tolling companies rather than with the integrated gas producers.) Second, the credibility of the major energy companies is extremely low. Wood Mackenzie, one of the leading research and consulting firms for the energy industry, recently estimated that during the last decade, “The 15 largest offshore projects were late and collectively $80 billion over budget.” Finally, we remain highly skeptical of the risk-reward profile in the next-generation LNG provinces, such as Mozambique.

Hence our approach to investing in commodity companies is really no different from our approach with any other sector. We look for companies with a unique and scalable asset base, management/owners who are culturally inclined to consistently create value, and stock valuations that, for some temporary reasons, reflect neither of these strengths. Our search has been global, but we have yet to find anything close to Novatek, a Russian-listed private gas company, which we have owned for 11 years (and counting). While the entire industry was suffering from a lack of capital discipline, Novatek launched its first and the world’s largest (non-government owned) LNG project – Yamal LNG – at the end of last year. It did so on time, on budget, and in the harshest environmental conditions imaginable (the Russian Arctic). It's estimated that it will be bigger in size than the infamous Australian Gorgon (Chevron) and built with less than half of the price tag.

Exhibit 5: Novatek’s Earnings Have Far Exceeded the Industry Average

And the hits will keep coming. Novatek’s long-term strategy sets a target of 57 million tons of LNG production by 2030, while its current resource base supports more than 70 million tons, around the same level that Qatar produced last year. Given the Russian government’s focus on developing LNG, the company's flawless execution over its 24-year history, and its strong partners like France's Total SA and China’s CNPC, we see a bright future for this company, which remains our single best idea in the global energy space. After all, there are not too many energy firms that we know about that have demonstrated more than 19% return on equity every year since at least 2006.

Exhibit 6: Novatek Has Also Posted Impressive Long-Term Returns