T. Boone Pickens Backs Natural Gas as Transportation Fuel

High diesel prices promote investment in alternatives. It makes sense to replace diesel engines with natural gas engines in many applications. So several companies and cities are remaking their truck and bus fleets to run on natural gas. Waste Management (NYSE: WMI) operates a fleet of nearly 500 gas-powered trash trucks. Several cities are shifting their bus fleets to gas; 20% of all new transit buses on order have natural gas engines. This is a viable, rapidly growing industry and a few companies will benefit.

Clean Energy Fuels (NASDAQ: CLNE) is one of these companies. It’s leading the charge to promote natural gas as a transportation fuel. It builds the infrastructure necessary to store and dispense natural gas at fueling stations. It’s also backed by billionaire investor T. Boone Pickens.

Pickens is a great energy investor. He made his fortune investing in oil and gas. He’s often been right about the big picture in energy, spotting trends long before the crowd. Today, he expects a future in which oil and diesel prices remain very high and consumers will use natural gas to fuel many more types of vehicles. He controls 60% of Clean Energy’s stock, a stake worth $400 million. That’s a big bet, even for a billionaire.

But there’s one big hurdle to his vision. Pickens knows the U.S. natural gas market as well as anyone, and he says he expects it will remain tight. Domestic gas drillers are working as fast as possible to meet demand from power plants, chemical plants, and homes. A growing fleet of natural gas-powered vehicles would propel natural gas demand to another level, spurring huge investments in liquefied natural gas (LNG).

Most of the world’s natural gas reserves are located far from major population centers. When gas is too expensive to transport by pipeline, it’s called “stranded” natural gas. The only way to get stranded gas to market is to cool it until it reaches a liquid state and transport it on ships designed to carry LNG.

Pickens’ vision of the future, along with continued global growth in gas demand for industrial uses, sets the stage for a massive boom in LNG infrastructure. Douglas-Westwood, a leading industry authority, forecasts investment in the LNG supply chain to grow dramatically over the next four years and beyond.

The importance of natural gas extends well beyond its role as an emerging transportation fuel. It’s a vital feedstock in electricity and chemical production. Synthetic nitrogen fertilizers, which use natural gas as a feedstock, greatly enhance agricultural productivity. Other chemical compounds created from gas are the building blocks for electronics and plastics. Gas is also becoming a popular fuel for home heating. Natural gas furnaces are much more efficient than oil or electric heat furnaces. Without natural gas, many businesses would simply have to close their doors. Reliance on natural gas is a weak link in the global economy.

Because of its importance, governments and industrial companies will keep favoring policies that secure reliable natural gas supplies. Since the industrialized world no longer includes just North America and Europe, many more countries have entered the competition to lock up the most promising stranded gas reserves.

For decades, LNG has not been cost competitive with oil and coal. But continually rising oil prices are heightening the sense of urgency to develop a tradable LNG market. Also, climate change activists will keep pushing to tax, regulate, and eventually banish coal. This benefits LNG because natural gas electric power plants can replace coal plants. The financial and political incentive to develop the world’s stranded gas reserves is strong and growing. Energy companies are responding.

Even Exxon Mobil – a consistent optimist about plentiful future oil supplies – doesn’t assume the United States has enough domestic natural gas to meet growing demand. “Energy independence [within 20 years] is just impractical, and we will have to rely on additional imports of natural gas,” says Ron Billings, Exxon’s vice president of Global LNG.

The Wall Street Journal recently reported on Exxon’s plans to build a huge LNG re-gasification terminal 20 miles off the coast of New Jersey:

“Exxon said it expects demand for gas to rise in North America, outstripping the ability of gas drillers and producers to keep up. Globally, it said, LNG demand could more than triple, to 500 million metric tons a year, in 2030, from 150 million metric tons a year today. About 20% of gas consumed in North America could be imported by then, up from 3% today.”

Like the U.S., China produces almost enough natural gas to meet its needs. Both countries rely on LNG to satisfy the extra 2-3% of domestic demand not met by local production. China’s use of LNG is small, but it can grow dramatically. China is an underserved market. It’s consuming as much gas as its limited pipeline and LNG capacity will allow. Supply constraints and high costs force many Chinese provincial markets to use coal for electricity when they’d rather use gas.

Residents of Beijing and Shanghai would certainly prefer gas-fired power plants to the coal-fired plants currently ruining air and water quality. Until now, China has constructed coal-fired plants at a maddening pace simply because they were cheap. But the health costs resulting from coal-based pollution are growing to a critical level. As Chinese wealth grows, the country will look to secure a leading position as a consumer of LNG – much in the same fashion as Japan. It may be more expensive, but China will weigh the extra cost of gas over coal against the benefit of lower health care costs and better social stability.

Chinese land drillers are pushing very hard, yet still cannot satisfy demand. China’s onshore oil and gas basins are fairly mature. State-controlled oil companies have been scouring the country for decades. Offshore drilling may eventually bring more gas supplies online. A few promising underexplored basins exist in northwestern China. But the pipelines necessary to deliver this gas to coastal cities will take years and tens of billions of dollars to build.

Chinese leaders have signed long-term gas supply agreements with the leaders of Turkmenistan and Kazakhstan, two Central Asian countries endowed with plenty of untapped reserves. But Gazprom, the Russian gas monopoly, also wants access to these reserves. The pipelines required to transport this gas would be very expensive and risky from a geopolitical perspective. The Chinese would probably find it easier to safeguard LNG supplies sourced from emerging exporters like Qatar, Malaysia and Australia.

I expect China will increasingly turn to LNG to satisfy growing natural gas demand. But it must compete with the rest of Asia, the U.S., and Europe to invest in the most promising LNG projects. Many European countries are looking to diversify away from politically risky Russian gas supplies. They’re investing in LNG projects that strengthen connections to longtime suppliers like Algeria.

Since natural gas provides the building material for so many modern products, its consumption grows as living standards improve. According to the BP Statistical Review, the entire Asia-Pacific region consumed just 3% of global natural gas in 1975. This figure expanded fivefold, to 15%, by 2006, and this trend should continue on its current course.

Japan was the first Asian country to invest heavily in LNG facilities. After suffering through the oil market disruptions of the 1970s, Japanese leaders decided it was wise to diversify supply of hydrocarbons. South Korean gas demand accelerated from a low base as its industrial machine matured in the 1990s. There’s an interesting aspect about the natural gas market in these two economic powerhouses: Neither of them has a viable domestic gas resource. They both rely on imports. Japan relies on LNG for 97% of its gas and South Korea relies on it for 100%.

Japan consumed 39% of the world’s LNG supply in 2006. South Korea came in second, at 16%. Both countries have a huge stake in LNG, so they will keep expanding their LNG re-gasification and storage infrastructure. LNG equipment companies have the opportunity to meet this demand over the long term.

Recent events have caused Japanese LNG demand to accelerate. Japan suffered a powerful earthquake in July 2007. It reignited fears of radiation leakage from nuclear power plants, forcing the shutdown of a major nuclear reactor. Ever since the shutdown, Japan has had to make up for the lost electricity with gas-fired power. Utilities have been importing as much LNG as storage facilities will allow, paying premiums of about 50% over benchmark U.S. natural gas prices.

After this scare, it appears that the Japanese government is rethinking its commitment to new nuclear reactors. In a recent research note, Bernstein Research described this important policy shift, which remains below the investment community’s radar screen:

“As a result of new [Japanese government] guidelines, nuclear plant operators will now have to analyze seismic events over a 130,000-year period, in stark contrast to the current mandated 50,000-year period. Geological faults screened to be active… would nullify greenfield site proposals, and could lead to closures of operating nuclear capacity…”

Nuclear power supplies 30% of Japan’s electricity. Regulators may delay or cancel some of the 10 gigawatts in new nuclear capacity slated to come online by 2015. If this happens, Japan’s LNG and gas-fired power facilities must expand.

Dan Amoss
for Markets and Money

Dan Amoss
Dan Amoss, CFA is managing editor for Strategic Investment and a contributing editor for Whiskey & Gunpowder. Dan joined Agora Financial from Investment Counselors of Maryland, investment advisor for one of the top small-cap value mutual funds over the past 15 years.

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