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What Chevron's 50% Stake in Kitimat LNG Project Says About Natural Gas

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Encana and EOG will sell their respective interests, resulting in a 50-50 joint venture between Chevron and Apache.

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MINYANVILLE ORIGINAL Encana Corporation (NYSE:ECA) and EOG Resources, Inc. (NYSE:EOG) received quite the Christmas present this year. On the eve of the holiday, Chevron (NYSE:CVX) announced its decision to purchase a 50% stake in the Kitimat LNG export terminal and Pacific Trail pipeline, both based in British Columbia, from Encana and EOG, although specific figures regarding gains on the sale were not released. After beginning operations, the Kitimat facility is expected to export approximately 0.7 Bcf/d (billion cubic feet per day). The Pacific Trail pipeline will have flow capacity of about 1 Bcf/d. For the sake of reference, according the Department of Energy's Energy Information Administration, Japan imported approximately 1.04 Bcf/d of LNG in 2011.

The overall result of the sale is a 50-50 joint venture between Apache Canada (NYSE:APA) and Chevron – in order to establish the partnership, the following three steps comprise the deal:
1. Chevron will pay an undisclosed sum for a 60% stake from EOG and Encana.

2. Apache will pay $150MM to Chevron to increase its stake in the project to 50%.

3. Chevron will pay $550MM to Apache for a 50% stake in approximately 644,000 acres worth of natural gas fields in the Liard and Horn River basins, both of which are located in northeastern British Columbia.

As a result, the project is vertically integrated from the natural gas source (Liard and Horn River basin fields), through the pipeline (Pacific Trail), all the way to the liquefaction process (Kitimat).

With the deal to be completed in 1Q 2013, expect Chevron and Apache to provide updated capital expenditure figures during upcoming earnings releases (in January and February, respectively), as the project is sure to require significant cash outlay before operations finally commence in 2017.

With regard to the raw economics of LNG, specific to the project's geography, spot price natural gas at Alberta's AECO-C hub, which generally serves as a benchmark for much of Western Canada, has traded in the range of $1.50 to $3.50/MMBtu in the past year. In both Japan and Korea, for example, the Federal Energy Regulatory Commission expects an average price of $15.38/MMBtu for LNG in January 2013. In the past year, prices topped $18 in Japan. This "arbitrage" is the impetus behind the development of several LNG export facilities worldwide in recent years – a price difference that companies like Chevron and Apache certainly hope will sustain in the long run in order to allow them to take advantage of a significant profit margin.

The announcement of the purchase suggests two potential inferences. First, and perhaps most visible, is that Chevron is a significant believer in the strategic importance of LNG in the future and seeks to diversify its portfolio through Kitimat. Chevron is currently invested in a joint venture with ExxonMobil (NYSE:XOM) and Royal Dutch Shell (NYSE:RDS.A) through the Gorgon project, an LNG facility off the coast of Western Australia. Incidentally, Apache and Chevron are already engaged in a joint venture through the Wheatstone project, another LNG facility also off the coast of Western Australia; it is expected to begin production in 2016.

Second, and related to Chevron's considerable experience with the construction of LNG facilities, is increased confidence that Kitimat will materialize into reality. In May, after Shell announced that it would also develop an LNG export facility in Kitimat, the increased competition served as a substantial setback. During the fall, Apache announced that it could not set a concrete date for construction and was also looking for buyers of a 20% stake in the project to raise additional capital.

In comparison to facilities such as Cheniere Energy, Inc.'s (NYSEAMEX:LNG) Sabine Pass terminal on the Gulf Coast, the Kitimat facility is, simply put, much closer to demand in Asia. As a result, it will naturally and more likely serve Asian markets while Gulf Coast terminals are better suited for European demand, thus the two regions are not in direct competition for exports.

Following reduced reliance on nuclear power generation in the wake of the Fukushima disaster, in addition to the worldwide shale production boom, expect LNG to serve increased importance in years (if not decades) to come.
No positions in stocks mentioned.

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