Cheniere LNG: What Carl Icahn Got Right
The big news in the LNG world this week has been the ouster of Cheniere’s CEO Charif Souki after a tense weekend meeting of Cheniere’s Board of Directors. As a shareholder of Cheniere (I own ticker “LNG” and “CQP”), I was surprised at the abruptness of Mr. Souki’s departure, which comes just as Cheniere’s Sabine Pass LNG export facility is finally about to come on-line with first gas expected to ship in early 2016. While the timing took me by surprise, I wasn’t surprised by the change itself since over the past year, legendary activist investor Carl Icahn has built up an almost 14% stake in Cheniere, making a shake-out at Cheniere almost inevitable.
Since there have been many articles about Mr. Souki’s departure, this post will focus on filling in some of the missing details on how Cheniere has upended the traditional LNG contract structure and why it matters to the global gas industry. This post builds on my prior post, LNG and the Price of Oil, as well as my LNG book, Energy for the 21st Century: Opportunities and Challenges for LNG, in which I profile Cheniere’s path from LNG importer to LNG exporter and the complicated US LNG export approval process.
It’s All In the Contracts
As noted in a recent Wall Street Journal article, Mr. Icahn was “attracted” to Cheniere’s stock by the long-term contracts Cheniere has with multiple buyers. The following is a snapshot of Cheniere’s contracts for Trains 1-5 of Sabine Pass LNG taken from Cheniere’s October 2015 Corporate Presentation.
In my prior post, LNG and the Price of Oil, I noted that most of the world’s LNG contracts are linked to the price of oil (“oil-linked pricing”). Cheniere’s contracts are revolutionary since they are NOT linked to oil but to Henry Hub as shown by the "LNG cost of 115% of HH.” This means buyers, or “offtakers” of LNG from Cheniere will pay 115% of HH for the gas plus a fixed fee of $2.25-$3.00/MMBtu to liquefy that gas into LNG so it can be shipped around the world. Cheniere structured the 20-year contracts as “take-or-pay” style contracts, which means buyers have to pay an annual fixed fee just for the option to liquefy gas at Cheniere’s facility. In other words, Cheniere will get these fixed fees even if buyers do NOT take any gas. As you can see from the slide, these fixed fees are significant -- $2.9B of annual revenue for 20 years.
If buyers do take the gas, then they pay Cheniere 115% of HH for that gas. It’s important to note that this does NOT mean Cheniere just gets 15% over HH – it’s possible for Cheniere to make more IF Cheniere can source gas for LESS than HH.
Destination Flexibility is a Key Feature of US LNG Contracts
Another very important aspect of US LNG contracts, that’s not mentioned in the above slide, is that US contracts have NO destination restrictions, which means US LNG can go virtually anywhere in the world. This destination flexibility is a departure from traditional LNG contracts and is one of the key features desired by buyers of US LNG.
From Cash Cow to Something Else?
Looking at the contracts, it seems that Cheniere was on track to become a real “cash cow” with at least $2.9B in fixed fees and even more revenue if offtakers took their annual contract quantities at 115% of HH.
More recently, however, the outlook for US LNG exports has dimmed as falling oil prices and weak demand have dragged down the spot price of LNG around the world and reduced the arbitrage opportunity for US LNG exports. Nonetheless, Cheniere insists that it “can profitably provide LNG to global buyers at attractive prices.”
Since I’m not an analyst and I don’t have all of the details (e.g. how and at what price is Cheniere sourcing its gas supply and do offtakers intend to take that gas?), I don’t really know whether Cheniere will be the cash cow I thought it would be when I bought shares in the company. Even more puzzling has been the expansion of Cheniere’s corporate structure and business model into something I can’t really sort out from these two slides. I am hoping that going forward, Carl Icahn and his team can sort it out for me and other investors.
What Carl Icahn Got Right About Cheniere & US LNG Exports
At the end of the day, I think Carl Icahn got it right when he focused on Cheniere’s unique contract structure. There’s no doubt in my mind that Cheniere has shaken up the traditional LNG contract model and introduced something revolutionary that will change how LNG is traded in the future. I also think the long-term outlook for US LNG exports in general is quite favorable since US LNG should be some of the least expensive LNG to develop and is appealing to many buyers looking to diversify their LNG supply with flexible, hub-indexed LNG.
I credit Mr. Souki and his entire Cheniere team for having the vision and determination to make US LNG exports a reality against almost insurmountable odds. Cheniere has truly been an amazing company to watch and I am grateful to many people there who provided insight and information for my book.
I don't really know whether Mr. Icahn and the Board made the right call in replacing Mr. Souki now, but according to an interview in Bloomberg, it seems that Mr. Souki thinks it may have been the correct decision if the board wants to run Cheniere as a “quasi-utility” with a less entrepreneurial CEO.
It’s too soon to tell how things will shake out at Cheniere and for US LNG exports in general. So for now, I’m taking Mr. Souki’s lead and strapping on my skis and heading to the slopes . . . Happy Holidays!
Visiting Professor, Univ. of Houston Law. Author: Energy for the 21st Century: Opportunities and Challenges for LNG