Attentive investors may have noted an announcement last week by the
large South Africa-based energy and chemicals company
Sasol (SSL).
The firm said it was commencing an eighteen-month feasibility study
to determine the commercial viability of one of two options: either
a two million tons per annum or four million tons per annum
Gas-to-Liquids, or ‘GTL,’ production facility in southwestern
Louisiana.
This would be the first GTL facility in the United States, indeed
in the Western hemisphere. The liquids produced are expected to be
generally kerosene and allied products, for diesel or jet
fuel.
This could be the start of a major movement to, effectively,
substitute abundant, cheap natural gas produced within North
America, for expensive, imported crude oil. The economic, balance
of payments, financial and investment implications are
enormous.
Heretofore, this potential substitution has been stymied by a
‘chicken and egg’ problem. Advocates of greater use of natural gas
as a transportation fuel -- people like T. Boone Pickens, and the
largest developer of shale gas,
Chesapeake Energy
(CHK) -- have run into the practical obstacle of natural gas not
being a convenient choice for consumers, businesses or
institutions.
Vehicles have to be fitted with adaptation devices and hardware,
plus a large tank to hold compressed natural gas, or ‘CNG,’
squeezing out useful luggage space in passenger vehicles and
potential cargo space in trucks and vans.
Futhermore, finding stations able to sell CNG at high volumes,
dispersed conveniently in cities, towns and along highways, is
nearly impossible and would be costly to deploy on a large scale,
even if such equipment could be put in place at existing service
stations. These stations are owned by integrated oil companies who
are not entirely positively disposed to cannibalizing their
existing conventional gasoline sales, nor cluttering up and
complicating their current operations with a new one of uncertain
demand level.
So, this new development is extremely positive from a standpoint of
encouraging the demand for and consumption of natural gas in a
different and much more user-friendly form. Truckers, bus lines,
delivery companies, railroads and airlines do not have to change
anything about how they operate. In fact, the diesel and aviation
fuel from GTL plants, as demonstrated by the ones already built,
separately, by Sasol and
Royal Dutch Shell (RDS.A)
in Qatar, have less contaminants than ‘natural’ kerosene fuels
refined from crude oil, and burn cleaner, too.
The United States currently consumes over eighteen million barrels
of crude oil per day, about twelve million of it imported -- at a
cost, today, of about $1.08 billion, or about $400 billion per
annum, at today’s price of about $90 per barrel.
That is money that leaves the United States economy and contributes
to its chronic trade and balance of payments deficit. The revenue,
aside from Mexico and Canada, generally goes to unstable,
unfriendly, despotic and/or corrupt regimes in the Middle East,
Africa or Latin America, fuelling war, repression, terrorism or
misery of one kind or another.
Should that money stay at home, it would be spent in communities
across the U.S., benefiting consumers and businesses, generating
jobs, and improving state and federal finances, lowering
deficits. It would also encourage the growth of a new
industry that would revitalize many sectors, in construction of
facilities, manufacture of sensors, controls, and other tools and
devices, and specialized equipment used in GTL and related plant
and infrastructure.
Companies involved in the construction of the Qatar GTL plants
include
KBR, Inc. (KBR),
Chicago Bridge
and Iron (CBI),
Honeywell (HON),
Flowserve (FLS) and
Foster
Wheeler (FWLT). In general, heretofore, GTL projects have
not been major revenue generators for any of these companies, as
there have been few of them, and they are constructed over
protracted time periods. However, it is quite possible that could
change in the near future.
Background
Converting to volumes, the indicated proposed capacity would be
about 2.4 million cubic meters per annum for the smaller option, or
4.8 million cubic metres for the larger one. Converting from
metric, that would be an output of 22 million barrels per annum for
the small facility, 44 million for the large one.
Other sources indicate that, owing to the nature of the process,
approximately 11 thousand cubic feet of natural gas are required to
produce one barrel of the liquids in these types of
facilities. So, annual consumption of gas for the smaller
facility is about 240 billion cubic feet; approximately 480
billiion cubic feet for the larger option.
This is significant but not substantial; the U.S. produced about 22
trillion cubic feet of natural gas from all sources in 2009, so the
smaller plant would consume about 1 percent of total U.S. supply by
the time it is built and started; the larger one, 2 percent. That
is not enough to drive up natural gas prices, especially with the
current, and likely continuing, surplus of shale gas.
Indeed, some natural gas drillers are running into some unexpected
cash flow issues, and have curtailed their drilling plans, or are
shifting their emphasis to more ‘liquids-rich’ shale prospects, as
light oil and other liquids are also produced in conjunction with
much of the shale gas.
Economics of GTL
Using the crude numbers available: if diesel fuel persists at its
recent wholesale price of about US$2.10 per gallon, or US$88.20 per
barrel, and natural gas hovers in the range of $4 per thousand
cubic feet, then Sasol’s gross margin would be in the neighborhood
of $44 per barrel, which, on the surface, looks very lucrative, and
compares very well to many unconventional sources of oil such as
the Athabasca oil sands in northern Alberta, Canada.
It looks even better when considering that, in effect, the Sasol
GTL does not require a refinery; it is, in essence, already
refining the input resource into finished, high value products. So,
the ‘spread’ from the substitute for crude oil to the finished,
‘refined’ liquid is very high.
The only real risks or concerns, other than environmental, cost
overruns, terrorist vulnerability, political or other ‘black swan’
events, are the normal ones of fluctuations in commodity prices --
specifically, a drastic spike in natural gas prices, or a prolonged
slump in the price of oil, and, consequently, oil-based liquid
product prices. Neither of these appears to be likely, and could
also be partly or wholly hedged against, if judged appropriate and
cost-effective to do so.
As these sorts of plants are very capital-intensive, and have a
small labor component, the operating cash flow will be very high,
and the free cash flow not much lower, depending on the quality and
durability of the initial construction. Depreciation would be
significant, as they are multi-billion dollar plants. Actual
physical depreciation should be much lower, hence the high free
cash flow.
Sasol, and even more so Shell, experienced significant cost
overruns in their Qatar GTL plant construction. However, both of
them appear to have learned from the experience, and, indeed, their
timing was unfortunate, as those plants were built in the late
2000’s, in a period that saw a frenzy of energy-related investment
and demand for labor, materials and equipment just prior to the
recession of 2008. These drove up prices and prolonged the
construction periods.
It seems that both companies are still quite positive on GTL, and
encouraged to invest in it in the near and extended future.
Depending on what happens in Lousiana in the next two years, other
energy companies could decide to imitate them, and take advantage
of low feedstock costs.
ExxonMobil () and
Chevron
([url='https://ca.advfn.com/p.php?pid=qkquote&symbol=cvx%5Dcvx%3C%2Fa'>),
also have large shale gas divisions, from recent acquisitions. They
are undoubtedly reviewing what to do with their burgeoning gas
output.
A much longer-term concern that seems too remote to call a
‘danger,’ perhaps ever, is that the GTL trend becomes so popular
that demand for natural gas drives prices for it up, and production
of the liquids output increases to such an extent that their prices
fall.
That is a ‘problem’ that long suffering companies like Chesapeake,
EnCana (ECA),
Cabot (COG),
Forest Oil (FST) and Devon (DVN) would love to
have. Given the capital commitments, very long construction
periods, and sheer abundance of natural gas in the United States,
Canada, and elsewhere, this potential issue would seem to be a
fantasy at this point, and certainly not a ‘nightmare’ that needs
to be taken seriously; not for many years to come.
Politics and Environment
Politically, it would seem to be the proverbial ‘no-brainer’ to
support the development of GTL and associated energy
infrastructure. Indeed, Bobby Jindal, the Republican governor of
Lousiana, was present at Sasol’s press conference announcing the
feasibility study. GTL, as such, has not entered the U.S.
presidential election rhetoric as yet, but shale gas and energy
policy in general already have, and, should either the Senate or
White House change control to a more business and
energy-development-friendly orientation late in 2012, it could be
very positive for the whole industry, and perhaps GTL in
particular.
Substituting domestic natural gas for imported crude oil
accomplishes many things: cleaner energy use, helping local
industry and employment, reducing balance of payments problems,
improving public finances, decreasing energy dependence on
unfriendly or unreliable foreign sources, and reducing the money
flowing to erratic or violent regimes.
Shale gas development has been one of the few bright spots in the
U.S. economy in the past three years. GTL can amplify and broaden
the benefits beyond places like North Dakota, Texas, West Virginia
and rural Pennsylvania.
The shale gas industry is addressing groundwater and other
environmental concerns brought about by fracturing practices (aka
"fracking"), and -- in Canada, at least -- is making progress in
getting rational, tight, explicit regulation enacted. The drillers
are also doing a far better, and more proactive job of public
education and awareness.
It is not essential for politicians to embrace shale gas and GTL
development for both to be successful industries, although it would
be helpful. They already have a bright future now, regardless of
the current sad natural gas price. Investors should look closely at
the sector; this could be one of those rare opportunities to get in
on the ground-floor of a brand new industry at a relatively bargain
price.
CHICAGO BRIDGE (CBI): Free Stock Analysis Report
CHESAPEAKE ENGY (CHK): Free Stock Analysis Report
CABOT OIL & GAS (COG): Free Stock Analysis Report
CHEVRON CORP (CVX): Free Stock Analysis Report
DEVON ENERGY (DVN): Free Stock Analysis Report
ENCANA CORP (ECA): Free Stock Analysis Report
FLOWSERVE CORP (FLS): Free Stock Analysis Report
FOREST OIL CORP (FST): Free Stock Analysis Report
FOSTER WHELR AG (FWLT): Free Stock Analysis Report
HONEYWELL INTL (HON): Free Stock Analysis Report
KBR INC (KBR): Free Stock Analysis Report
ROYAL DTCH SH-A (RDS.A): Free Stock Analysis Report
SASOL LTD -ADR (SSL): Free Stock Analysis Report
EXXON MOBIL CRP (XOM): Free Stock Analysis Report
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