Cheniere Energy: Poster-Boy For The Shale Gas Hallucination

Wolf Richter knocked it out of the park on this one. During the LTM period ending in June, Cheniere Energy had negative operating income of $235 million, yet sported a TEV (total enterprise value or market equity plus debt) of $27 billion! That's a negative multiple of 100X. Likewise, during the last five years its stock price has soared from $3 per share to $72, while its net loss has swelled by 27X--- from a run rate of $20 million to $535 million.

Needless to say, Cheniere's $9 billion of debt and $18 billion of market cap in the face of massive losses and negative cash flow constitutes a huge bet on the distant future of LNG exports and a massive arbitrage between the depressed price of natural gas in the US and much higher prices abroad.  But as Richter shows, that whole scenario amounts to a wild hallucination that is incompatible with the laws of economics and the facts on the ground with respect to the US shale gas drilling binge.

At the end of the day, the whole shale gas story is another giant deformation flowing from the Fed's financial repression.  The industry has drilled on Wall Street for massive amounts of cheap debt and other capital which generated a one-time spurt of  fraked wells and initial production. But the latter cannot be sustained due to the devastating decline rates of fraked wells. At today's prices most of the dry gas shale wells ever drilled in the US are under-water economically, and the industry collectively has generated hundreds of billions of economic losses.

So the shale gas story is not about an economic miracle, the wonders of technology, the prowess of job creators or the virtues of mindless slogans like "drill baby, drill".  Instead, its a place where the cheap capital enabled by central banks goes to die.


LNG Chart

By Wolf Richter at Wolf Street

America is on the verge of becoming a natural gas net exporter in a year or two. It can relieve energy-starved Japan from extortionary prices and free Europe from the clutches of Gazprom. A number of liquefied natural gas (LNG) export facilities on the Gulf Coast and on the West Coast have been approved, are under construction, or are in the pipeline, so to speak. Untold riches await daring investors.

Or so it would seem, according to the hype, often as thick as San Francisco fog in the summer, that has shrouded the segment of the industry. Some stocks of companies hoping to ride that LNG export boom are soaring. Billions, mostly borrowed from unsuspecting or blind lenders of one type or another, have already been spent, and many more are going to be spent, on highly capital-intensive LNG export terminals.

For example, Cheniere Energy which by now is famous for producing ever increasing losses on declining revenues: in 2013, it generated $507 million in losses on $267 million in revenues – which is quite a feat! The losses are up 156% from 2011, while revenues are down 8%. It now has $9.5 billion in debt, up from $3.3 billion in 2011. Its stock price soared from penny stock in 2003 to over $40 a share in 2006 and 2007, before it revisited the penny stock purgatory in 2008. Then in 2012, the LNG export hype began wafting around its operations, and the stock soared again, and it recently spiked, and closed today at $72. It’s been one heck of a ride.

How can this insanity occur? Consensual hallucination. Analysts, hype mongers, company pronouncements, free money from the Fed, and willing traders or investors - all are part of it. For them, the outfit is a highly leveraged arbitrage wager on the difference in natural gas prices in the US, Japan, and Europe.

In the US, natural gas prices in electronic trading are currently below $4 per million Btu. In Europe they’re more than twice as much, in Japan more than four times as much. But processing natural gas into LNG in the US and transporting the LNG from the US to Europe or Japan is going to eat up a chunk of that price differential.

So the stock is a nose-bleed bet that the price in the US will remain this low, and that prices in Japan and Europe will remain high, and that contracts are signed to reflect these price differentials for years to come.

This assumes that there will be natural gas to export.

But there has been a hiccup: the US is a natural gas net importer, still, despite years of “over-drilling” and a presumed natural gas “glut” that whacked the price below the cost of production, where it still languishes today.

The US currently exports natural gas via pipelines to Mexico and Canada, but it imports even more natural gas via pipelines from Canada (in addition to a small amount of LNG from overseas). The chart, based on the EIA’s latest data through May 2014, shows the net results from the drilling boom: the US remains a net importer of natural gas.


So what natural gas exactly are these LNG exporters going to export?

Currently, US production doesn’t meet domestic demand. Period. The hole is filled with imports from Canada. Large-scale LNG exports remain a pipedream for the moment. Unless a miracle happens, and they’re unlikely in the oil and gas business, US production might meet domestic demand without reliance on imports by 2018. And if production continues to grow beyond that, the US might eventually produce enough to become a net exporter of significant quantities of LNG.

But there has been another hiccup: Drilling for dry gas has been grinding to a halt. By last week, only 313 rigs were drilling for natural gas across the country, down from 1,606 in September 2008.

Production is up, but these production increases come mostly from the Marcellus shale where an enormous drilling boom over the last few years left thousands of gas wells without pipeline connections. Now that the pipeline infrastructure is catching up, take-away capacity is rising. Gas that is taken to market is counted as “production.” But many of those wells that are now responsible for the increase in production were drilled years ago.

Yet drilling activity – that is, future production – in the Marcellus shale is a shadow of its former self: In January 2012, 143 rigs were drilling for gas; in the most recent week 77 rigs. Fracked wells have steep decline rates. And after 18 months, production has petered out to only a small fraction of initial production. Once the steep decline rates catch up, production in the Marcellus is going to taper off.

Only a new drilling boom could re-launch production.

And there we have a third hiccup. The current price is simply too low to justify fracking for dry gas, though if the well primarily produces oil and natural gas liquids, which sell for higher prices, and dry gas is merely a byproduct, the equation is less dreary. So for that new drilling boom to take off, the price would have to be significantly higher.

Hence the fourth hiccup: these significantly higher prices of natural gas in the US that would be needed to restart the drilling boom also destroy the highly leveraged arbitrage bets that LNG export investors are counting on in the first place. But consensual hallucination allows for no doubts and no paradoxes. Reality no longer matters. What matters instead is the Fed’s limitless, nearly free money and the plentiful availability of corporate and Wall-Street hype.

David Stockman's Contra Corner is the only place where mainstream delusions and cant about the Warfare State, the Bailout State, Bubble Finance and Beltway Banditry are ripped, refuted and rebuked. Subscribe now to receive David Stockman’s latest posts by email each day as well as his model portfolio, Lee Adler’s Daily Data Dive and David’s personally curated insights and analysis from leading contrarian thinkers.

Get Access