Cheniere's Marketing Profits Fall Close to Normalized Levels in 2024

Strategist

Stephen Ellis

Cheniere is well positioned to be the exporter of the incremental liquefied natural gas supplied to the global market over the next few years, particularly as demand ramps up from China. We expect Cheniere to have about 45 million metric tons per year LNG capacity on line in 2022, 55 million tons in 2026, and 58 million tons in 2028. We expect the bulk of China's LNG demand growth to be met by U.S. gas supply, given the United States' ability to increase gas and therefore LNG supply significantly. 

That said, volatility in the market should provide ample opportunities for Cheniere to take advantage of wide LNG differentials at different hubs around the world. This paid off in 2022 with LNG spreads at record levels given huge EU demand for LNG. The benefits are sizable, and we estimate Cheniere reaped almost $6 billion in excess marketing profits in 2022. 

Cheniere has made a final investment decision on Corpus Christi Stage 3, a 10 million metric ton per year-plus expansion. We model this expansion as contributing materially in 2026 after a late 2025 start. Cheniere is also fully permitted on two smaller trains, 8 and 9, for about 3 million metric tons per year, which we expect will eventually obtain a final investment decision in 2025. We expect the trains to move forward and enter service in 2028 because Cheniere already has about 3 million tons of capacity under contract beyond its existing capacity and construction plans.

The massive 20 million ton Sabine Pass expansion, announced in early 2023, will likely require almost 30-35 million tons of contracts, assuming optimization opportunities at existing trains, and it is uncertain whether all of the trains will move forward. The three-train expansion (or about 6.7 million tons per train) was decided in part, due to the need to source power from Texas and likely coal-fired power generation. Currently, a final investment decision for at least one phase is targeted by Cheniere in 2026. This meant that larger trains were needed to improve the overall per-train economics versus using gas-fired power generation and the resulting lower emissions.

Business Strategy & Outlook

We think Cheniere Energy and Cheniere Partners have wide moats due to an intangibles moat source. The intangibles moat source is derived primarily from the 20-year take-or-pay contracts that both entities have signed with multiple customers to liquefy natural gas that essentially put Cheniere in an incredibly strong competitive position as a pure toll-taker with no commodity price risk. We don’t see any contract renegotiation risk due to the attractive features of the contract, and to date, only non-Cheniere contracts have been challenged, mainly because of the oil-linked status and current poor economics. About 85%-95% of capacity per train is under contract with the remainder available for marketing purposes. These contracts provide Cheniere with a fixed fee ranging from $2.25 to $3.50 per thousand cubic feet plus a variable fee set at 115% of Henry Hub to cover the cost of acquiring natural gas and operating the terminals. Cheniere to date has been very efficient from an operating performance perspective (about 112%), thus earning a small margin on the variable fees. Returns on invested capital at midcycle will be around 14%. We expect the source of economics rents from a contractual perspective for Cheniere is due to its assumption of construction, gas procurement, operational, and long-term export viability for U.S. gas risk. 

Our midcycle forecast for returns on invested capital has increased to 14% from 11% over the past few years. A material driver behind the increase is the per-train capacity increase to about 5 million tons per year from about 4.0 million-4.5 million tons per year in 2018. This improvement is linked to operational efficiencies on Cheniere’s part and essentially results in much higher profit per dollar of capital investment than originally expected. 

In Cheniere’s case, we consider contract coverage to be the most important factor influencing its moat. The entity’s asset quality is very good, given its sizable position as an owner (directly or indirectly) of LNG facilities in the U.S., but it does not benefit from an efficient scale or cost advantage moat source. 

Cheniere’s contracts are highly unusual in the LNG market and provide numerous advantages. Historically, LNG contracts have been linked to oil prices either via S-curve or slope pricing. In recent years, contract pricing has shifted more toward hub pricing to the detriment of companies such as Gazprom but to the benefit of Cheniere, given the significant growth in low-cost U.S. gas (and therefore Henry Hub pricing), making U.S. LNG exports an important driver of global LNG pricing. Typical LNG contracts contain clauses that allow price revisions either after a certain period or if oil prices rise or fall outside of a certain range, allowing customers to flex the amount of LNG delivered in any given year while holding them to the contracted quantity over the full contract, and they have restrictions on where the gas can be shipped. Customers are also responsible for the procurement of gas.

In contrast, Cheniere’s contracts do not have clauses allowing price revisions, do have complete freedom on destinations (allowing the gas to be shipped to the most profitable market), and are linked to Henry Hub instead of oil (thus cheaper), and Cheniere takes on gas procurement and operating risks. These contracts are similar to what U.S. peers such as Cove Point and Freeport have signed. From an operational perspective, Cheniere has been performing well, and it has linked short- and long-term contracts with pipelines such as Williams’ Transco to supply all of the gas needed for the terminals.

Cheniere also benefits from its reputation as a reliable LNG supplier, which we think helps attract and retain customers. Supply security is critical to its customers that depend on reliable gas supply to ensure their own plant and utility economics. To date, its terminals have entered service on time and on budget or in some cases, ahead of schedule and below budget. We think its reputation has been enhanced in recent years, as other LNG suppliers have demonstrated to be less reliable and less customer friendly. One example is the explosion at the U.S. LNG terminal Freeport in mid-2022, which ultimately remained offline well into 2023. Freeport essentially stranded its customers with no gas supply during an energy crisis in the EU, forcing them to pay huge premiums to acquire gas elsewhere with little to no reported financial assistance from Freeport. Another example is Venture Global’s Calcasieu Pass (trains 7-9), where its extended commissioning process has delayed the start of contractual service dates with customers, leaving them short of gas during a difficult market. The firm has sold over 200 LNG cargoes since 2022 in an extended commissioning process (virtually all firms only sell one to three cargoes), reaping billions of dollars in profits in an extremely tight gas market, frustrating its customers that expected to receive their contracted supply amounts in a timely manner. 

We do not think Cheniere earns an efficient scale or cost advantage moat source for a few reasons. From an efficient scale moat perspective, we consider the LNG market to be global; Cheniere has exported gas to over 40 different markets to date, and within 10 years, it expects to reach 60 markets. The global nature of the market means that Cheniere has to compete on new greenfield and brownfield capital costs, availability and cost of gas, and transportation costs. The U.S. market and by extension Cheniere have generally attractive brownfield investment opportunities but suffer from higher-cost gas compared with Qatar and West Africa, as well as unfavorable transportation economics to key demand centers such as China and Japan. The biggest advantage that Cheniere has here is the significant amount of U.S. gas production coming on line over the next decade, versus competing production from stranded offshore projects internationally, letting it compete more effectively for incremental gas demand. As a result, we expect the bulk of new LNG global demand to be met by U.S. gas supply. Competing pipelines transporting gas to, say, China from Russia would also be considered competition for LNG. The large market size means that there is no efficient scale moat source in play. Further, while there are hurdles to overcome from a regulatory approval perspective (environmental, permitting, state and local issues, non-free-trade agreements), and capital costs (terminals can cost $7 billion-$10 billion), we do believe they can be overcome. Cheniere’s 45 mtpa makes it a sizable player, but the market will continue to expand. Due to the lack of cost advantage on the actual feedstock and the more fleeting advantages around capital intensity (around brownfield mainly because of the greenfield capital investment already spent) and transportation costs, we find it difficult to assign a cost advantage moat source.

Cheniere and Cheniere Energy Partners have yet to lay out any material ESG-related targets. Cheniere is working on collecting greenhouse emissions data across the LNG value chain in order to proactively address new European Union methane rules coming into force in a few years.

Wide

Economic Moat

Cheniere Energy

Cheniere Energy, Inc. engages in liquefied natural gas (LNG) related businesses. It owns and operates LNG terminals, develops, constructs, and operates liquefaction projects near Corpus Christi, Texas, and at the Sabine Pass LNG terminal. The company was founded by Charif Souki in 1996 and is headquartered in Houston, TX.

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