Energy Transfer: The Lake Charles Debacle And Why You Should Buy (NYSE:ET) - Seeking Alpha

Energy Transfer: The Lake Charles Debacle And Why You Should Buy (NYSE:ET) | Seeking Alpha

Energy Transfer: The Lake Charles Debacle And Why You Should Buy
Energy Transfer LP (ET) 43 Comments

Summary

- Energy Transfer's Lake Charles project, the largest proposed natural gas export terminal on the Gulf Coast, recently had its permit extension denied.
- Despite denial, the project makes too much sense to not complete.
- The project's potential impact is not fully reflected in Energy Transfer's current pricing, and if the project succeeds, it could result in significant upside for the company's stock.

nikkytok

The Lake Charles project has been an ongoing debacle now for a while for Energy Transfer (NYSE: ET). Recently they got some poor news from the Department of Energy regarding it. In this article, I'll explain the project, and the news in question so you have a better understanding of the topic.

Then, I'll go into why I believe the project will be a significant upside catalyst for ET, and more importantly why I believe it's not built into current pricing. This is a stock that could potentially see a +50% upside in capital appreciation, not to mention the incredible distribution yield. And better yet, I believe that comes with very low downside risk.

The Lake Charles Project, Explained

Lake Charles Project Location (Energy Transfer LP)

The proposed LNG export terminal project would be the largest natural gas export terminal on the Gulf Coast and would have a liquefication capacity of 16.45 million tonnes per annum. The facility also has approval from the US Department of Energy to export up to 2.33 billion cubic feet of natural gas per day, a massive amount of natural gas.

The proposed Lake Charles LNG export project will use the existing infrastructure of the import and regasification facility and will occupy an additional area of 240 acres at the Lake Charles LNG facility. There will be three trains located at the facility as well. This project will be directly connected via pipeline to the Henry Hub located in Erath, Louisiana - which provides access to nine interstate and four intrastate pipelines.

Energy Transfer has already gotten offtake commitments for 50% of the LNG it would be exporting from various governments around the world and has spent around $350 million in development costs thus far on the project.

The Situation, Explained

Energy Transfer, one of the largest midstream companies in the world with arguably the most diversified energy portfolio in the world, was dealt a major setback to the project as a result of recently regulatory changes by the US Department of Energy. Essentially, the DOE export license is no longer certain as it could take longer than expected to begin those exports, and the DOE is denying ET's requests to rehear deadline extensions.

As it stands Energy Transfer has two years to begin construction and then file for an extension. However, the company would likely need to make a final investment decision long before construction can start - and lenders and counterparties could balk at a final package now that the DOE export license is in jeopardy. Climate activists across Louisiana celebrated the temporary win while Energy Transfer slammed the original decision from the Department of Energy.

Without diving into any kind of political debate here, it's pretty clear that Energy Transfer feels like the decision by the Department of Energy was politically motivated and "raise[s] serious constitutional concerns of lack of due process and impermissible takings" as the company wrote in a federal filing.

The company also put out the following statement: "We believe the Department of Energy made a flawed decision related to Lake Charles LNG as it made no effort to ascertain the actual status of the project before making its ruling." To be frank it's rather difficult to disagree that this decision seems irrational.

It seems that the Department of Energy refuses to acknowledge the 2020 Covid lockdown years as any kind of significant delays and unforeseen challenges for Energy Transfer - despite our country essentially shutting down for 2 years while manufacturing halted and supply chain issues sprang up everywhere and in every industry. Not to mention global demand for LNG crashed with the world locking down.

No, according to the Department of Energy, Covid-19 wasn't a significant enough event to be even considered in delays to the company making a final investment decision due to equipment shortages, supply chain disruption, and global demand crash.

A possibility is that the Department of Energy is stonewalling due to election season coming up soon. This was a celebrated win by climate activists, with The Vessel Project of Louisiana saying in a statement"The Department of Energy announcement to change the way it approves requests by LNG companies to extend deadlines is a step in the right direction towards environmental justice for all."

While the company says the ruling by the DOE "will likely result in the project's demise," the project itself makes way too much sense for the domestic natural gas market on too many levels for it to be abandoned completely in my view.

I think there is a decent chance for a change to the US administration during the election next year. Not trying to be political here, but Biden's ratings are quite low, with only a 40% approval, and 54% disapproval. Historically speaking, presidents with approval ratings that low face a much lower probability of re-election.

And if the Republican nominee wins the Presidency, investors can likely look forward to more oil & gas friendly drilling policies and less restrictive environmental policies and regulation. In this specific case, investors can look for Energy Transfer to refile an appeal once the change has occurred and would likely be granted the three-year extension it is looking for - which would be all systems go for the company's future.

The only question that remains is whether the company will be forced to make a final investment decision before that time comes.

Is Lake Charles Built In To Energy Transfer's Pricing?

A small piece of the potential pie is, but it mostly is not. Read on.

Of course, the preferred method for answering this question would be a quantitative one. I'd favor a discounted cash flow model. But building such a model would require significant estimation, research, and time - and likely would still be inaccurate due to the guesswork involved. As such, building a model like this will be beyond the scope of this article.

Because of this, we'll attempt to answer the question with a combination of qualitative and quantitative instead by analyzing the emotions of market participants on the stock charts. And you'll see that this actually provides a simpler, quicker, and potentially more authoritative answer.

In order to continue, we need to accept some premises so that I can walk you through my argument that it is not heavily built into pricing.

Premise 1: When a project is heavily figured into stock pricing, positive and negative news regarding the project can move stock prices and cause volume spikes in trading as participants react in a "knee-jerk" and emotional manner.

Premise 2: If a project is not built into stock pricing, and/or has become immaterial to current and potential investors, then news regarding the project will not move stock prices or cause volume spikes.

Premise 3: The Lake Charles project is valuable to Energy Transfer, and will result in significant cash flow upon completion.

Premise 4: The cash flow that would result from the project's completion is so significant that it will raise Energy Transfer's profitability by an amount that will cause a change in Energy Transfer's valuation. For comparison, Lake Charles will export 2.33B cubic feet per day, and Energy Transfer's entire Permian region operations move 2.8B cubic feet per day.

If we accept these things, then let's examine the impact of positive and negative news on the stock charts, starting with the most recent first. The day in question will be highlighted with a black arrow.

22 June, 2023 - The DOE rejects the rehearing appeal.

Stock chart of ET for 22 June, 2023 (Author)

As we can see, prices fell a small amount that day. No spike in volume. It opened with a long candle down -0.43%, and mostly kept flat. Recovering prices a few days later. It's difficult to attribute this to the news though, as all of XLE fell on 22 June.

23 May, 2023 - ET filed for rehearing.

Stock chart of ET for 23 May, 2023 (Author)

A small spike, and sell down by close. Again, the chart for XLE looks identical so it's difficult to attribute a green day to the news.

21 April, 2023 - The DOE announces ET's permit extension rejection.

Stock chart of ET for 21 April, 2023 (Author)

This is what I consider to be the "smoking gun" supporting my argument. On the day that the DOE announced it was completely rejecting the extension for the export timeline, virtually nothing happened to the stock. I don't have an exact time that the announcement was made, but the article linked is ostensibly prior to market close.

Regardless, following the announcement the stock fell for a couple days the next week in line with XLE, after regaining all of the loss on the 27th. That doesn't seem like the stock action one would expect if the full impact of the Lake Charles project was indeed built into the pricing for ET.

So this leaves us with two possible answers.

Either A: The full impact of the Lake Charles project is not built into the pricing for ET.

Or B: Nearly the entirety of current market participants in ET feel there will be no impact from the DOE's decision as to the success of the Lake Charles project. They may feel it will succeed or fail, but either way there was no impact.

Given the company's aggressive response to the DOE's decision, and their talk about Lake Charles on company press releases and conference calls, and the $350M they've spent on it, we have to assume the company believes that Lake Charles will be important to their future. If the company believes that, and is part of their long-term outlook projections, then it seems highly unlikely that market participants would believe it would have zero impact on the company.

Market participants may believe the project will happen anyway, which is certainly a possibility and a risk to this analysis, but it seems even more unlikely to believe that all market participants in ET would be in agreement to this end. The markets never agree on anything completely.

Which leaves us with option A. This is why I believe that the full positive impact of the Lake Charles project is not built into pricing at this current time, and indeed perhaps only a very small amount of it is. This would seem to indicate that if the project succeeds, we could expect significant upside to the stock pricing. If it fails, we will likely see only a very minimal downside since it currently is not built in to an appreciable degree - and in fact the failure of the project may be built in.

Price Targets

What pricing level could we see? That's a difficult question to answer, but I'll hypothesize.

Revenues would be inherently very difficult to predict from this project at this point. They will be highly variable based off of numerous factors including demand for LNG, how many contracts can be secured, what the volume pricing is like in those contracts, and about 90 other things. Again, predicting this with a complicated model would be beyond the scope of this article.

Instead, let's look at Wall Street analyst price targets. They're not always the most accurate, but it's going to give us somewhere to start. Again, look at this with the assumption that Lake Charles is not currently heavily built into stock pricing.

ET Stock Price Targets from Wall Street Analysts (Seeking Alpha)

With an average price target showing $17.28, that gives us the current upside of 34%. That seems high at first glance given the stock's price history, since it's been stuck below $13.50 for some time now.

But now consider that the Wall Street analysts have more time than we do, they're smart people, and they have fancy computers and machine learning models. Not to mention they have interns to do research for them. Isn't it conceivable that the Lake Charles project may be built into their price targets?

So if we move forward on that theory, we can see that with the Lake Charles project which will be undoubtedly large boon to ET (even if they divest some interest in it to maintain financial leverage ratios) there is a potential highly significant upside to the stock - on the magnitude of over +50% for the higher targets. And given that we believe it's not currently built in, the downside is negligible.

Looking To The Future

If this project goes ahead, what does that mean for Energy Transfer as an investment?

While the short-term outlook for natural gas prices looks relatively flat with marginal rises, the long-term outlook by a heavy majority of folks in the industry has natural gas prices steadily rising in the coming years. Right now there is a significant contango in natural gas futures, with Henry Hub for Dec 2024 coming in at $4.23 as of today.

Global demand for natural gas is also expected to steadily rise in the coming years with demand in China leading the way in the short term as the country continues recovering from strict Covid-19 lockdown restrictions. Domestic natural gas companies have stepped in dramatically to capture a much larger share of the world's natural gas export supply. This makes the need for major export terminals like Lake Charles LNG that much greater.

Some investors might not be aware that Russia was the biggest supplier of natural gas to Europe and for many years was the world's largest exporter of natural gas. However, after the invasion of Ukraine and cutting supply to Europe, the global landscape of how natural gas flows has changed dramatically - with the U.S. now leading the world in natural gas exports.

You won't see these massive shifts in the global supply flow reflected in prices, but it's important for investors to be aware of this change in dynamic as global supply security now essentially lies in the hands of the United States. That makes projects like this all the more important.

While there is certainly significant risk exposure to this project being shelved altogether, the upside for Energy Transfer if this project ultimately goes through is astronomical (even if they divest a portion of it to another company). As it stands there is still too much uncertainty surrounding this project for many analysts (and certainly any retail investor) to include the project in their valuations - but make no mistake if this project is greenlit the stock price will certainly increase.

Investors should certainly keep their eyes on news and events surrounding this project as once the rest of the market values this project into the price of the stock, the opportunity will have passed for investors to make what could be monumental profits. This project makes way too much sense on too many levels to be shelved completely.

The opportunity has risen for the U.S. to become the sustained global export leader in natural gas and to further help global energy security, and this new export terminal would make this possible. While political grandstanding is common during election seasons, this opportunity is bigger than any administration's political motivations - and for that reason alone the project should ultimately go through in my opinion.

Conclusion

Once that project becomes official, investors can expect the stock price for Energy Transfer to significantly rise in the coming years as it becomes an unquestioned global leader in natural gas exports. Pricing today does not reflect that eventuality in my view.

Risks to my analysis can include the complete failure of the Lake Charles project, although for the reasons I've stated I don't believe it will happen. The project would be a major opportunity for the United States to become a worldwide leader in LNG exports - and that's likely a bigger return than placating a small portion of a political leader's base.

Furthermore, the company may decide to continue with the project anyway, despite the extension denial, if they feel they can complete it in time. They've dragged their feet for a while over the project (I believe they've attempted to have the capacity under contract prior to FID), but again I think it simply makes too much sense for them to cancel at this point.

They will likely end up with a partner in the venture since it's very expensive and legacy debts on their balance sheet continue to require servicing. They were 50/50 partners with Shell, until Shell pulled out in 2020, so it seems likely they'd look for another 50/50 partner.

Another risk could be Russian relations with Europe returning to a pre-invasion state, but I consider this to be highly unlikely even in the event of the war ending. Even if these things happen, I believe that there is little to no downside in the stock currently given their industry positioning.

The last risk I see to my analysis is oversaturation of the export market. There are currently numerous projects permitted and in construction, although none as large as Lake Charles. However given the likely rise in demand for LNG exports it's reasonable to assume that ET would be able to acquire contracts for exportation through their facilities - especially given their economy of scale and ability to offer very competitive pricing.

Overall I think this represents a significant value opportunity for the dividend investor with a high upside, and minimal downside. I have to believe the project succeeds, and even if it doesn't I believe ET is in a perfectly fine situation and will continue to pay their substantial distribution to investors. I have to give this one a strong buy rating.

About this article:

When I research stocks, I start with a "bird's eye view" of the target company. When this bird's eye view is complete, I'll decide if I want to avoid the company for the time being or if it's a potential candidate for investment. This article that you are reading is the result of my bird's eye view examination.

It is designed to be an overall, high-level view of the company that you can read to determine if this company is something that you might consider as a candidate for investment. It is not possible to report everything about a company in the space of a single article, nor is it possible for me as an author to learn every detail about a company in the amount of time allotted to write an article.

You should not take my final conclusion on the company as your sole recommendation for investment, and you should conduct further in-depth research on your own to come to your final conclusions.

As a result of this, my "buy" recommendations come with an asterisk. And that asterisk is that this is only a high-level examination, and in-depth research that can take many hours, or days, of your time is still required. This is why my articles are short and to the point, with no fluff or filler. Just the facts that you need to know to move forward.

This article was written by

Analyst’s Disclosure: I/we have a beneficial long position in the shares of ET either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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