Tuesday, May 13, 2014

The Myth of Cheap U.S. Natural Gas: Opinion

NEW YORK (TheStreet) -- We're hearing plenty of talk that the U.S. has been pushing the E.U. to enact sanctions against Russia related to its actions towards Ukraine. If the E.U., as an ostensible extended arm of the U.S., were to get further involved in the game, it's likely the natural gas supply across the region would be severely hampered. 

The E.U.'s involvement in the conflict region, sanctions or otherwise, should be for its own independent reasons and not premised on the erroneous belief in the salvation of supposedly cheap U.S. natural gas.

The development of the so-called shale gas boom in the U.S. follows a script employed by Wall Street: A topic is medially placed. Investors begin with high expectations and then securities are purchased for which the buyer assumes big profits based on production forecasts. In order to meet these expectations, the business is expanded, invested and promoted without regard to the real financial situation and the actual costs of operations. Option programs serve some decision-makers here as a thinking aid. The capital expansion is funded through the sale of new shares, bonds or structured vehicles.

Grotesquely high exhaustion rates of the gas fields, which let the prevailing expectations from investors (and politicians) appear completely ridiculous, join a below-cost production. From politicians we are accustomed to thinking in terms of legislative periods, investors should do better.

Selling U.S. subsidized gas to Europe is discussed as the new savior for the financially troubled industry. However, while Europe is dreaming of procuring cheap gas because gas is less expensive in the U.S, the U.S. expects extra revenue due to higher gas prices in Europe. This difference has not been acknowledged, yet. Ultimately, how can an entity sell its product for a profit, off site, when it is unable sell the exact same product onsite? Include the horrendous costs of the transportation and compression to LNG (liquefied natural gas) and the profit margins are further reduced. Apart from that, the conditions are present for neither an export nor for cost-covering production and the dreamy forecasts to the centenarian reserves meanwhile dissolve in hot air. The cheap energy supply to the E.U. by shale gas is a myth. The sooner one realizes this, the less money burnt and the less foreign policy porcelain is damaged. These gas companies must raise investment capital that would not or could not get covered by the sale of new shares. And investors in the commodity sector tend to forget the dilution effect, which is brought by the offering of new shares.

In a similar field, buyers of mining stocks still wonder why their stock prices are stuck in the muck. The expansion of the field of view and the inclusion of the market capitalization of each company is pretty helpful. It turns out that many business valuations are not as diluted their stock prices suggest. Rather, the number of outstanding shares has been increased by constantly offering new shares to the chagrin of owners of old shares. Wall Street, it seems, has orchestrated the shale gas boom and, in so doing, searched for alternatives to the constant sale of new shares. Voila: Volumetric Production Payments (VPPs) were born. With this type of financing, the company receives capital from a buyer and sells entitlements to future production. In other words, the company remains the owner of the assets, but sells a portion of its future production. For shareholders, this is not a windfall. While this method creates no dilution, future earnings are diminished. This type of financing is similar to classical royalty-structures in which commodity buyers are able to acquire large flow rates on the products in advance. The only condition is that the expected quantities actually can be encouraged. In shale gas there is every reason to doubt that this will occur. According to Surge Capital, these companies are currently using this structure: Noteworthy is the percentage of output obligated. If shareholders wonder why, even in better times, they end up with less than expected return, the answer can be explained by the table above. The juxtaposition of the total value of production based on the sale price of the said shares is also noteworthy. The investor can see how little it may be worth it if a company is debt free. Both, the permanent dilution and the irreversible sale of future production harms the investor. As a result, I recommend a close look at a several year worth of annual reports before investing mid to long term. >>Read More: 'Peak Oil' Burned as Exxon, Chevron, Shell See $100 a Barrel >>Read More: Big Coal Is Downsizing in China, and Stock Investors Like It >>Read More: Cool Heads Quietly Dominate Heated South China Sea Dispute At the time of publication the author held no positions in any of the stocks mentioned. Surge Capital Corp. chart used by permission. This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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