NATURAL GAS:

Cheniere walks financial tightrope as it banks on LNG export boom

Cheniere Energy Inc. is closing in on its goal of becoming the first company to export natural gas from the lower 48 states, following six months of deals that may have finally resolved investors' persistent doubts.

Since October, the Houston-based company has closed four deals to supply liquefied natural gas, or LNG, to utilities abroad. Then, last month, it signed a $2 billion deal with private equity titan the Blackstone Group, securing critical funding toward a $5 billion export terminal.

The company still needs $3 billion and a final federal permit before it can build the facility at Sabine Pass, La. But the flurry of deals may calm investors who, for the past year, had been questioning whether Cheniere had the cash and the customers to become a successful exporter.

"Until we started signing commercial contracts, nobody took us seriously," Charif Souki, Cheniere's chairman, CEO and president, said in an interview with EnergyWire. "We signed that first commercial contract in October. So in three months, we lined up $2 billion, and the banks are going to follow pretty quickly. That is very, very quick."

After devoting most of the past decade to the natural gas import business, the company was caught flat-footed by a U.S. gas boom that rendered it nearly obsolete. Instead of crumpling, management proposed a double-or-nothing strategy: Build export terminals to sell cheap U.S. gas into pricey European and Asian markets.

The roller-coaster ride continues for Cheniere's stockholders, who saw the Houston-based company's "LNG" ticker on the New York Stock Exchange plateau at around $40 a share in the mid-2000s before diving to $1.12 in the fall of 2008. Slowly, Souki and management have punched their way out of that pit, convincing investors that while they misjudged on imports, the export market is here to stay. Cheniere closed at $14.39 on Friday, and its shares climbed past $15 during trading yesterday amid speculation that gas buyers in India are looking to sign more long-term LNG deals.

Now, Cheniere's plan for Sabine Pass is first in line for U.S. approval. Another seven applications trail behind, including a second by Cheniere. Pending a final approval by the Federal Energy Regulatory Commission, Cheniere plans to begin construction at Sabine Pass this summer, adding an export facility to the existing import terminal. Gas shipments would start in 2016.

The linchpin of the company's new business model is its supply contracts: four deals, with utilities in the United Kingdom, Spain, Korea and India, that aren't for gas, exactly, but for the rights to gas.

For utilities in Europe and Asia, where natural gas can cost four or five times what it does in the United States, having those rights is valuable. And for Souki, they are reliable cash flow as Cheniere claws its way out of $2.7 billion in long-term debt.

He said his markets are BG Group PLC, Gas Natural Fenosa, KOGAS and GAIL in India. "That's my market. They have to pay me whether they take the gas or not. They're going to pay me a total of $2.5 billion a year, for 20 years, whether they take the gas or not," he said.

"So in that context, I go to Blackstone and I tell them, 'Do you want a piece of this?' and they say yes. And then the balance I get from the banks," he said.

Capitalizing on the oil-gas gap

So goes the argument: Solid contracts attract marquee financial backers, which means kinder loan terms from the banks. Once that happens, Souki said, the only issue is how to slice the pie among themselves.

To get there, Souki and management are pitching that the LNG market is here to stay: that European and Asian prices will stay above U.S. prices well into the future, making them steady export markets.

William Frohnhoefer, an analyst at BTIG LLC, paraphrased the second pitch this way: "Even if we're dead wrong where natural gas prices are headed ... if we have an exact repeat of what happened with the original Sabine Pass project, this time we've got all the customers signed up ahead of time. That's different from last time."

If the LNG export market takes off, it will be driven by arbitrage, economists' term for the profit-taking that comes with different prices in different places.

As proponents argue, the United States is staring at a gaping hole between domestic and foreign gas prices. In the United States, oversupply has driven prices into the dirt, but prices remain high abroad. That's partly because shale gas hasn't been tapped yet, but it's also because some markets tie the price of natural gas to the price of oil.

Cheniere wants to capitalize on that gap. In a March presentation, it claimed it could deliver gas from Sabine Pass to Europe or Asia for $8 to $10 per million British thermal units. If the local market ties gas to oil prices, the gas could be sold for $11 to $23 per million Btu.

One question is how long and how wide the arbitrage window stays open. Floundering U.S. prices have energy producers looking offshore, where the gas can fetch a better return. But most analysts expect U.S gas prices to rebound eventually, and LNG supplies out of the United States, Europe and Asia could drive down prices where demand is the highest in Europe and Asia.

That narrowing gap could make it tougher for a company to pay off a $4 billion to $5 billion export facility, all while paying interest and hoping to turn a profit.

As consulting firm Deloitte LLP put it in a July report, "Exporting LNG from North America to Europe and Asia, while tempting now, may not prove to be profitable over the long term, especially if future technological advancements do not continue to significantly drive down the cost of producing shale gas."

Souki's response: See the contracts. Each year, he and his partners will charge $2.5 billion, regardless of whether the foreign buyers take the gas, regardless of where they go, no matter what gas prices are doing around the world.

Observers have noted the fine print. In February, just days after Cheniere signed its fourth customer contract, Standard & Poor's raised its credit rating a notch, to B-.

"Cheniere's abilities to improve its liquidity position and capital structure have become more credible," S&P said, citing the contracts with "creditworthy counterparties." By the end of the month, Cheniere had struck the $2 billion deal with Blackstone.

Costly perks for customers

The Blackstone deal came with a heavy price, however. To land an investor of that quality, Cheniere had to issue a new category of stock -- stock that pays Blackstone not in cash, but in more stock. When Sabine Pass begins to supply its second customer, the stock converts to common ownership of Cheniere Energy Partners, the subsidiary that now owns the terminal. But Blackstone's stock possessions will have so multiplied by that time that it will have four seats on the board of directors -- just as many as Cheniere Energy, the parent company, does.

If Cheniere has $2.5 billion of guaranteed income, regardless of whether it ships the gas, what's in it for Cheniere's customers? James Jensen, a private LNG market consultant, said it boils down to a new type of contract that's becoming the norm in the LNG business: "free on board," or FOB.

FOB is a sort of "no questions asked" policy for LNG exports: The instant the gas flows into the ship, Cheniere surrenders any say over where it can go. All four of Cheniere's supply contracts work this way, according to Jensen.

That has an interesting implication for the foreign utilities buying the gas. Intuitively, a utility company that sends a ship to Louisiana means for it to fill up, reverse course and haul the payload home. But increasingly, Jensen said, gas buyers keep one eye on world prices. They may have originally planned to deliver to one country, but if market conditions change, they have the right to ship to more profitable shores.

"When BG buys the gas from Cheniere, you don't know where the hell they could take it. They could take it anywhere. They're traders," Jensen said. "In each case, buying FOB, if they don't like the way the market is going, or the Japanese are in a panic and will pay real premium prices for cargo, they may go there."

Cheniere, of course, doesn't pilot the ships, so it can't enjoy the upside of this business: selling into the priciest natural-gas markets in the world.

On the other hand, the $2.5 billion of reliable contracts is what makes it possible for Cheniere to get financing where a riskier strategy might not.

For some, exports have proved too risky -- for now. Speaking at an investor meeting earlier this month, Exxon Mobil Corp. Senior Vice President Andrew Swiger said the company is tentatively looking at export markets from North America but isn't certain it will enter.

He distinguished between Exxon, which has three decades of experience in international markets, and "a number of people who have made a variety of announcements or jumped into permitting already."

The caution springs from "event risk." As the thinking goes, the market fundamentals of LNG exports are solid: There's demand for gas around the world, the price differences mean there's arbitrage to be had, and the United States holds the high ground, with some of the cheapest gas in the world.

'LNG needs to get things done soon'

For Cheniere, BTIG's Frohnhoefer said, it's not about the market factors.

For instance, like most observers, he believes Cheniere will secure its permit before 2013. But if it doesn't, he said, new troubles will arise. The $2.5 billion in contracts form the backbone of the company's financial and business model. But the contracts require Cheniere to meet certain construction milestones. If the company seems to fall behind on construction at Sabine Pass, its four customers could start questioning whether gas will ship by 2016.

In all likelihood, they would merely renegotiate the contracts. But the worst-case scenario is that they would exit the contracts entirely, pulling the rug out from under Cheniere's financial model, Frohnhoefer said.

"LNG needs to get things done soon," he said. "I think the sooner, the better, because while I don't think any push-out in terms of time will derail the project, I think you want to do everything you can to keep your customer and your builder and regulator happy."

Jensen fears another possibility for Cheniere and other exporters. All aspiring exporters must secure permits from the Department of Energy and FERC. Cheniere secured its DOE permit in May, but the agency said it will continue to monitor LNG exports, making sure they aren't diverting gas "needed to meet essential domestic needs."

"DOE is authorized, after opportunity for a hearing and for good cause shown, to take action as is necessary or appropriate should circumstances warrant it," the agency wrote.

That possibility could throw a monkey wrench into Souki's plans to get $3 billion from the banks, Jensen said. Lenders are used to carrying the bulk of the financing in a large project like this, he said, but how will they react if DOE reserves the right to cancel a project?

"The amount he's asking for in terms of bank finance is not out of line at all. What is kind of a ringer is this question that the U.S. is saying, 'Gee, we reserve the right to change our mind,'" Jensen said. "That, of course, introduces a tremendous risk."

The final, though perhaps most remote, risk is that Congress will seek similar powers. Two weeks ago, Sen. Ron Wyden (D-Ore.) said he hopes the United States will call a "timeout" on natural gas exports until regulators come up with tougher criteria. Last month, Rep. Ed Markey (D-Mass.) introduced legislation to ban the export of gas drawn on public lands and freeze all new export applications until 2025.

Asked whether he fears a congressional backlash against exports, Souki turns sarcastic. He pleads a "please regulate me" message: After all, if Congress doesn't want exports, or if it bans hydraulic fracturing, the price of U.S. gas will skyrocket, and he's already got the import terminals to get it from abroad.

"I'm a citizen. If Congress believes that I'm doing a bad thing, they should promote laws to prevent me from doing the bad thing I'm doing. I absolutely believe that. And I absolutely believe that Congressman Markey did the right thing. He didn't try to stop me behind the scenes; he didn't try to be less than direct about it," Souki said. "So I applaud what Markey did. I don't agree with him, but I applaud what he did."

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