On The Brink Of A Potential Asia-Europe LNG Bidding War, I Am Buying Shell

seekingalpha11-21 19:53

Europe's worsening natural gas supply situation and rising spot prices suggest an impending LNG bidding war, making Shell an attractive investment due to its robust LNG segment.The Dutch TTF spot ...

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As a result, European spot prices rose significantly above Asian LNG spot prices, making it increasingly likely that we will see the start of a bidding war for LNG supplies between the two continents. I decided to buy shares in Shell (NYSE:SHEL) as a way to invest based on this thesis, given its robust LNG segment, even though the obvious first choice might be Cheniere (LNG). The significant valuation gap is the main differentiating factor that made Shell my first pick, over a pure LNG play. There is also the product diversity factor, where a pure LNG play may have some extra upside potential but also far more downside risk for investors, if the bullish LNG price thesis fails to pan out. The recent buy signal convinced me to switch from hold to buy I last covered Shell in 2022, when I highlighted its push to expand into green energy to partly offset its upstream production decline, at which point I had its stock on hold. One of the main reasons I did not have it as a sell was because of its LNG segment, which I saw as one of the strongest arguments to hold Shell stock in the past, ever since its BG merger. It is thanks to that merger that Shell is currently attractive as an investment opportunity within the context of an impending LNG bidding war between Europe and Asia, with Europe particularly getting desperate to maintain its storage levels at a level that is seen as safe in a post-Ukraine war reality. That new safe level is seen as reaching near 100% full capacity every fall. We are currently at 91% full capacity and unlike last year when storage levels were still rising in November, this year we saw a dramatic decline in storage levels in the past 3 weeks or so. Celsius. Due to this development, the Dutch TTF spot price is crossing above the Japanese/Korean JKM spot price, signaling that Europeans are increasingly feeling the need to start outbidding Asia for LNG deliveries. Oilprice.com I covered this potential European energy crisis in the making in more detail in a previous article, which provides more details on Europe's supply/demand situation & outlook. Shell is set to reap the rewards of its long-term strategy of betting heavily on LNG in the past decade. In 2023 Shell was involved in supplying 16% of the world's LNG exports. It also has ongoing projects in the pipeline that will keep it in a leadership position in this regard. At the same time, Shell's stock has been trading in correlation with oil markets, along with the rest of the industry, meaning that unlike Cheniere, its LNG potential is not as fully priced in. Choosing Shell over Cheniere comes down to valuation versus the potential benefits of a slightly overpriced pure LNG play After establishing the big-picture thesis of an impending LNG bull market, the next part was to choose a good candidate as an investing opportunity within the context. Cheniere is the obvious choice at first glance. A potential LNG bull market, in theory, is best played by investing in a pure LNG company. Looking at Cheniere's current forward P/E ratio of almost 19, it is easy to see how this might be a limiting upside factor for its share price. The downside potential can be potentially significant for a company that has a high valuation within the energy industry sector, and has been reaching new all-time highs in the past few months. Cheniere stock price and other metrics (Seeking Alpha) It is not the case with Shell, concerning its P/E valuation nor its recent stock price run. It is about 15% off from its recent highs. Shell stock price and other metrics (Seeking Alpha) In addition to being in line with most of the rest of the industry in terms of valuations, Shell also pays a far more generous dividend, making it a much more pleasant long-term buy-and-hold, if the results of the overall external thesis in favor of higher LNG prices take longer than expected to materialize. Shell derives a significant portion of its profits from its integrated gas segment, even though it lags in terms of revenues behind other less profitable segments For the latest quarter, Shell's net earnings came in at $4.9 billion, of which $2.6 billion came from its integrated gas segment. Shell As we can see, most of the revenues of $71.1 billion came from the marketing and chemicals segments, while most of the profits came from the LNG and upstream segments. Notably, the renewables segment continues to lose money, which might explain recent moves by Shell and other oil majors to shore up their upstream and LNG segments while putting less emphasis on renewables. Other financial results of note include a continued reduction in its debt from $71.6 billion at the end of 2023, to $64.6 as of the third quarter of this year. This is important because companies are having to roll over lower-interest debt incurred before 2022. The reduction in its total debt helped to keep interest payments for the first nine months of the year at $3.57 billion, up just slightly from last year's corresponding period of $3.51 billion. Interest costs amounted to 1.6% of total revenues. I tend to worry when interest costs surpass 5% of revenues on a sustained basis for most companies because at that point there is a risk of a vicious financial cycle. Shell's upstream segment may surprise on the upside if EIA & IEA are proven to be wrong on the oil market next year One key argument that can be made in favor of Cheniere as a better LNG investment over Shell is that the EIA & IEA both have negative outlooks for the global oil market for next year, which could negatively impact Shell's stock price if it turns out to be correct. They see this year's supply deficit situation reversed by the second quarter of next year, on weak demand growth and forecasts for robust supply growth. EIA As I pointed out in recent articles, I am currently skeptical about the institutional integrity of recent oil market forecasts. I see the IEA and EIA as trying to push oil prices down even as OPEC is trying to push prices up. OPEC has had to constantly reduce its demand forecasts, while the EIA had to reduce its US crude oil production forecast for this year and next. My personal view on the matter is that OPEC will continue to revise its demand forecasts down, while on the supply side, the IEA & EIA will be proven wrong, and they will have to downwardly revise supply growth projections. The net result will be a continuation of the current supply deficit situation into most of next year. In other words, the increase in supplies will not cover both the current supply deficit and growing demand, even if demand is not growing as fast as OPEC is forecasting. If I am correct, Shell is set to potentially benefit from higher LNG prices, as well as higher oil prices next year, which suggests that Shell being a diversified energy producer will not be as significant of a handicap relative to pure LNG producer Cheniere in terms of their comparative financial performance. Investment implications Shell has multiple potential paths to improved revenues & profits next year In a best-case scenario, LNG prices as well as oil prices are going to move higher next year, providing Shell with a significant boost to its financial results. Even if one of the two potential upside factors does not pan out, it should still see some resulting upside in its financial results. In this respect, Shell is an arguably less risky investment option, due to its more diverse profile. Risks to my thesis There is a chance that the LNG price rally will never materialize. Europe is in trouble, in part due to weather pattern issues. The weather is unpredictable, and we could have a windy, sunny, and warm winter which will reverse the current trend of seasonally sharp natural gas storage drawdowns. In that case, the bidding war for LNG that is just starting to take shape will fail to materialize. There is also a chance that even though the LNG price rally will materialize, it will be short-lived, and the market will not respond promptly, since Shell trades mostly as a typical oil producer, even though its LNG business is currently producing a higher share of the profits. By the time higher LNG prices will have an impact on its earnings, the LNG price rally could be coming to an end and investors will never see an expected Shell stock price rally. This is one aspect where Cheniere would be a potentially better pick if we had more certainty regarding an LNG price spike on the horizon. The market reaction will be more instant with a pure play like Cheniere. Finally, my ongoing worry when it comes to owning Shell stock is the fact that it is low on upstream reserves, and therefore there is a very real risk that its upstream crude oil production will plummet in the next few years. The implication for investors is that time is not on their side. In other words, the investment thesis must play out promptly, before bad news from the upstream segment starts to erode Shell's stock price. If it does not play out, I will probably consider selling and maybe taking a loss if a favorable exit point does not arise. Risk/reward looks attractive Though there are risks to my buy thesis on Shell, It should be noted that in the absence of drastic unforeseen events, as we saw with the COVID pandemic, the downside potential is low. Oil prices have not gone below $60/barrel for some years now, and the reason for this is that it is the threshold that tends to trigger severe reductions in shale drilling and to some extent a slowdown in oil sands expansion. Similarly, LNG prices are unlikely to drop much further from the current levels. Europe still depends on LNG to a great extent, and it is set to lose more Russian gas as well as the situation in Norway, where a steady long-term decline in natural gas production is forecast to begin right around now. On the other hand, if my thesis does pan out on LNG and oil prices, the upside potential for Shell's stock price is significant; therefore Shell stock is currently worth the risk. If its stock prices decline significantly from current levels while my investment thesis based on external factors remains intact, I intend to increase my position in the next few months.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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