Intermediate natural gas weighted stocks in Canada are valued higher—sometimes a LOT higher—than oil stocks, despite oil being worth 35 times more than gas.

And that could mean significant price weakness for already battered natural gas stocks, says Haywood Securities analyst Alan Knowles.

“People think (the stocks of) gas companies have corrected, but they’ve only partially corrected,” he told me in a phone interview.  “The correction hasn’t kept pace with how far it should have gone,” given how low natural gas prices have moved.

At first glance, Knowles’ says the gas companies are NOT valued more highly than the oils—but that’s comparing the two groups at the industry standard of 6:1; where 6 barrels of natural gas are considered equal to one barrel of oil.  See his chart below that shows this.  The green dots are the leading intermediate oil producers—Crescent Point, Legacy Oil and Gas, Baytex and Petrobakken, and the red triangles are the gas weighted companies.

The gas stocks are clearly cheaper on this chart, which measures them in terms of the value of their production — $50,000 per flowing barrel up to $250,000; again all based on the industry standard 6:1 ratio.

So this is how you would read the above chart…

Look at the red triangle symbol TOU, Tourmaline Energy, a heavily weighted gas producer. This chart shows they make just over $20/barrel profit, and for that they are valued at roughly $70,000 per flowing barrel of production.

Crescent Point (CPG), which is Canada’s leading intermediate oil and arguably the most successful and most respected management team in their sector, generates a profit per barrel of over $55… and the market values them at roughly $160,000 per flowing barrel.

But the big problem is that the value of gas is, on average, 35x less than oil—so Tourmaline and all these other gas producers should have their daily production levels divided by 35 to get an accurate comparison to oil producers, not 6.    And that creates a HUGE valuation gap for these stocks to contend with.

Knowles went through each producer under coverage to get a customized oil:gas ratio based on cash flow generated for each commodity—and the ratios for the gas stocks ranged from 29.9 – 41.5.  When you compare the valuations of all the companies on their true cash generating ratio of gas to oil, this is what the chart looks like:

Look where Tourmaline is now—at the top!

“Why should a gas company get so much more value than oil-weighted value?” asks Knowles.  “Almost all the gas guys are valued higher than CPG, and does that make sense?”

This chart shows that the 6:1 ratio of oil to gas is outdated. In fact, most people in the industry have been saying that for years.

“We have to rethink the 6:1 ratio,” says Knowles. “Two 50,000 barrel-a-day companies are not the same.  If one is half natural gas, all of a sudden they’re a 25,000 bopd company, from a revenue point of view.”

Knowles says his chart should be a warning to investors bottom fishing for natural gas stocks now.

“This is kind of a warning.  Gas prices were down 33% in Q1 and they’re down even more now.”  He says investors will finally understand how bad things are getting when natural gas companies start reporting their quarterly financials.

“It takes hard reality of financial results before it really hits home for a lot of people.  When we see it in black and white it will get crystallized—there will be some companies whose cash flow is devastated—especially on the juniors, they’ll be hard hit.”

He expects a lot of Canadian natural gas producers just won’t re-start production after this year’s spring break-up—the 4-6 week stretch where big trucks are banned from the thawing roads in western Canada.

Knowles is quick to point out valuations aren’t just in the numbers.  There are a lot of intangibles, like the Street’s opinion of management—that counts for a lot.

Take my example of Tourmaline.  Chairman and CEO Mike Rose is a legend, successfully selling Duvernay Oil and Gas to Shell for $5.6 billion in 2008. Few CEOs have as good a track record.  And that’s a big part of that stock’s valuation.

Later this year, Knowles sees the oil:gas ratio increasing to over 40 as Canadian oil prices increase.  He says that the reversal of the Seaway pipeline in the US—which will now take oil from Cushing OK instead of delivering it, will help Canadian gas prices.  Refinery turnarounds will also be a plus.

He sums up: “We think people have not adjusted to the reality of gas stocks.  They’re still looking at it as 6:1.”

by +Keith Schaefer

Where will the wealth created by the fast growing Liquid Natural Gas (LNG) market be concentrated in the coming years?

In a word–Australia. It’s the #4 exporter of LNG in the world already, and seven new plants are in various stages of planning and development, which would require $200 billion in capital investment–and lots of jobs.

By comparison, America, which produces massive amounts of natural gas, sends a shockingly small amount of the resource abroad.

Both are close to markets – Australia is closer to Asia, which imports vast quantities of LNG, but the U.S. is also relatively close to these markets and closer to Europe, which holds some major LNG consumers, like Spain and France. Both also have robust natural gas production.

And yet Australia is light years ahead of America in sending LNG overseas. How far? about 800 billion cubic feet (bcf) per year.

Now before we explore that gap further, here’s a short-version background on LNG…

LNG is created by cooling natural gas to minus 256 degrees Fahrenheit, which transforms the gas into a liquid. This liquid has about 1/600th the volume of natural gas, making its transport over long distances much simpler —and much more economic.

While turning a gas into a liquid may seem to be the stuff of science fiction, it has its roots in the 19th century when Carl Von Linde, an engineer in Munich, built the first practical compressor refrigeration machine. The first LNG plant was built roughly a century ago in West Virginia.

It’s not the Bakken most investors have come to know.

But I expect that all to change, especially now that one small company operating here has just hit TWICE on a HUGE new play–validating thousands of acres.

That’s why company insiders have been loading up on shares… AND why brokerage firms have price targets 50% to 100% higher than today’s share price.

As an OGIB reader, you can get the full update on this high-potential growth play — here in my new findings. Go here for free access.

Of course, large-scale users of natural gas prefer to deal with the regular kind–not liquid and frozen. Since gas is easier to move and doesn’t need to be refrigerated, companies had to then develop ways to reverse the process. So you have to liquefy the gas to move it, and then “re-gasify” the natural gas to use it.  That’s a lot of work and means large infrastructure investments are required.

The gas is converted to liquid at liquefaction plants (LNG export terminals.) It is then transported in special ships that use auto-refrigeration. These LNG ocean tankers actually use a small amount of the LNG – 3%-4% during an average voyage—to power the ships. These tankers can carry around 135,000 cubic meters of liquid natural gas, which works out to about 3 billion cubic feet of warm natural gas.

To give you an idea of how much gas that is, 23 ships a day could feed ALL the US demand for natural gas.  There are now roughly 375 ships in service worldwide.

The ships then go to an LNG import, or regasification, terminal where the LNG is converted back to a gaseous state and then either stored in tanks or sent through pipelines.

The Asian market is a major destination for LNG exporters. Japan is by far the world’s largest importer of LNG, bringing in nearly 71 million tons (8.52 bcf/d)—or almost 31 percent of all global LNG imports, according to Unit Economics.

South Korea is #2 at 34.5 million tons (4.14 bcf/d), or roughly 15 percent of global imports. Taiwan (11.3 million tons/1.36 bcf/d) and China (9.7 million tons/1.16 bcf/d) also account for a significant portion of LNG imports.

Asia isn’t the only major LNG import market, though. Europe brings in large amounts as well.  Spain is the third largest importer of LNG with 27.3 million tons (3.28 bcf/d) coming in during 2010. The United Kingdom and France are also major importers, bringing in 13.4 million tons (1.60 bcf/d) and 10.2 million tons (1.22 bcf/d) in 2010, respectively.

According to the U.S. Energy Information Administration (EIA), the U.K. received 55 percent of its LNG exports from Qatar in 2009. That same year significant quantities of the hydrocarbon entered the U.K. from Trindad and Tobago (a surprisingly robust LNG exporter with 15.4 million tons (1.85 bcf/d) sent abroad in 2010), Algeria, Egypt and Australia.

Now that we’ve covered the basics of LNG, we can dive into the LNG industry in Australia to see what the U.S. might learn from the Land Down Under.

Australia only trails Qatar, Indonesia and Malaysia in LNG exports. In 2010, Australia sent 872 billion cubic feet (about 19 million tons) abroad, which was a substantial improvement over the 714 BCF exported in 2009, says the EIA.

That’s just over 8% of the world’s LNG exports. By comparison, Qatar does 25% of all LNG exports. Unit Economics states that Australia could contend with the Middle Eastern country for top spot as early as 2016.

Not surprisingly, most of Australia’s LNG exports go to the Top 4 importing countries—all in the Far East. Japan gets about 70% of Australia’s LNG exports, China gets 21%, South Korea 5% and Taiwan 4%.

There are only two LNG liquefaction plants in Australia right now, but seven additional export facilities are under construction, and four more are planned. Unit Economics reports that if all of these facilities come on line and produce their projected capacities, Australia will send a staggering 95.7 million tons (11.5 bcf/d) of natural gas abroad per year, versus the 19 million tons (2.28 bcf/d) it is exporting now—a five-fold increase!

The capital investments—and the jobs created by it—are enormous.  The Australian major Santos Ltd., along with Petroliam Nasional Bhd., are planning on shelling out $45 billion to create three LNG export facilities that would be able to convert 20.8 million tons of coal seam gas into LNG each year, reports the Wall Street Journal.

Other prominent players in Australian LNG are the BG Group PLC and the Australia Pacific LNG consortium, which is led by ConocoPhillips and Origin Energy Ltd.

“LNG is simply in high demand. and it’s not just the consequence of Fukushima,” Jon Skule Storheill, chief executive officer of Awilco LNG, told Reuters, referencing the nuclear disaster in Japan that has prompted the country to rely more heavily on LNG. “There’s Korea, there’s Taiwan, this market is just strong. Gas is clean, it’s available and it’s cheap.”

America, on the other hand, has only two export terminals. The terminal in Kenai, Alaska, which was built in the 1960s, was idled in November of last year. (At the time, ConocoPhillips’ spokeswoman Natalie Lowman told The Associated Press the plant will be in preservation mode until spring 2012, at which time the company will re-examine the facility.)

The other is Cheniere Energy’s Sabine Pass LNG Terminal, near the border of Texas and Louisiana. This station has 4 billion cubic feet per day of capacity.

Overall, the US exported 0.2 bcf/d of LNG in 2011, according to the EIA—a total of 71.5 bcf.  Australia almost does that in just one month.  The U.S. sends most of its LNG exports to Brazil, China, Japan and South Korea.

So How Does the US Get In On the Global LNG Action?

The LNG market is growing, and its future looks bright.

Some industry analysts predict demand for LNG globally will increase 40% in the five-year period from 2010 to 2015. This would make the annual market for LNG roughly 300 million tons.

The U.S. has the fifth-highest amount of natural gas reserves in the world, with the EIA putting the number at 273 trillion cubic feet. By comparison Australia has the 12th-highest natural gas reserves, with “only” 110 trillion cubic feet. But, as  stated above, Australia was able to ship more than 12 times as much LNG overseas in 2010 than the U.S.

The largest obstacle the U.S. faces in the LNG market is its lack of export/liquefaction terminals. With the Kenai facility going idle, the Sabine Pass terminal is the only facility in America even close to being able to regularly send LNG overseas. And even that could still be a few years away.

Now what about building LNG liquefaction plants?  Unit Economics says it can cost $3 billion for each million tons of annual capacity for the entire liquefaction supply chain, which includes production, pipelines, the port and the facility itself.

The Wall Street Journal reports there are seven additional projects seeking approval from the Department of Energy to ship LNG to most foreign nations. If all of these projects gain approval they could handle about 25 percent of U.S. gas production. However, the news source reports that approval for all of the facilities is unlikely.

An additional hurdle to the LNG market in the U.S. is political opposition to sending the energy source overseas. The American Chemistry Council has warned the U.S. government that it “should not undermine the availability of domestic natural gas,” but is not necessarily against exporting the substance.

The Sierra Club is concerned that exporting more natural gas will cause companies to increase their fracking operations. While there has been little to no evidence that fracking itself harms the environment, a groundswell of opposition to the practice has emerged, making investing in greater production difficult for the industry.

Still, for all the hurdles in exporting LNG, the U.S. also many opportunities.

In mid-March Japanese officials planned to meet with a delegation headed by Deputy Energy Secretary Daniel Poneman to reportedly request LNG exports to Japan. This appears to be a major step, as Japan had previously shied away from American LNG due to uncertainty over whether Washington would allow it to be exported.

As mentioned, Japan’s thirst for LNG is insatiable, and it will only grow stronger as the country scales back on its use of nuclear power following last year’s Fukushima Daiichi nuclear disaster. (Before the disaster, nuclear power accounted for about 30 percent of Japan’s energy production. That’s a large hole Japan will need to fill.)

Other markets that could be exploited by the U.S. are the U.K., France and Spain, all three of which are among the largest importers of LNG in the world. While Australia does send some LNG to these European countries, most of the U.S. competition will come from African countries like Nigeria and Algeria, as well as Qatar.

Another positive sign for U.S. LNG exports is that they appear to have the support of Energy Secretary Steven Chu, who has stated that sending the hydrocarbon overseas would allow America to cut into its trade deficit.

“Exporting natural gas means wealth comes into the United States,” he said, reports The Wall Street Journal.

There is much work to be done in the U.S. LNG industry to help it catch Australia—but the economics are powerful if it can.  The gears appear to be moving in the right direction, as both international markets are opening up, domestic production increases and LNG liquefaction facilities gain approval and come on line.

– The OGIB Research Team