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LNG is a big story currently and a key part of this story is shipping, because it is central to the LNG story. Investors looking for immediate upside in the LNG industry might be interested in FLEX LNG (NYSE:FLNG) because it is a significant player, it is very responsive to its shareholders and is cautious about the future. Non technical types who assume it might be possible to quickly upscale shipping capacity and later have a transition from shipping LNG to shipping hydrogen, might think carefully about the comments from FLNG’s CEO in the Q2 2022 (August 2022) earnings call Q&A. However, currently FLNG is about as good as it gets for dividend investors.
There is a lot of discussion about the situation that Europe finds itself in due to the disappearance of Russian gas. Much of this discussion, including from the IEA, foresees elevated gas prices for some time and no obvious “quick fixes” that don’t involve continuing with fossil fuels, especially gas/LNG. But by the same token expanding fossil fuels, especially LNG, involves solutions that are not short term. For example, it is easy to be flippant about physical things like ships. Of course more can be built, but what does a ship cost and how long will it take to pay of the cost of construction?
As I discuss here, FLNG brings this back to reality and reality says to me that maybe the solution to the LNG shortage will come from another direction entirely. A core feature of the European response is to dramatically expand renewable developments (especially offshore wind). Renewable projects can be quickly implemented, but there have been regulatory issues built into these developments that slow them down. The urgency of the problem (even if that means next year as it looks like this winter might be under control) has led the EU Commission to see how these projects can be fast tracked. A key part of this initiative is to rapidly shorten permitting for renewable projects, not only wind but also rooftop solar PV. In addition, grid connections for renewable projects are being expedited. The EU Commission also highlights the efficiency and ease of using electric heat pump replacement for gas heating. In other words the plan is to fast track renewable supply, while seeking to reduce demand for gas/LNG.
The above is the context in which I view FLNG. I assume that it isn’t just European authorities seeking solutions to massive increases in the price of LNG. The climate crisis and recent COP27 brings into focus the need to exit fossil fuels urgently, but COP27 also shows how much difficulty the developed and developing worlds are having with how to address the crisis. There is a lot of change in the air.
FLNG: outstanding in yesterday’s world
As always, I get a lot of information out of quarterly earnings reports. Here I refer to two such reports, Q2 2022 (August 2022) and Q3 2022 (November 2022). These reports and the Q&A sections helped provide me with an insider industry view of the LNG industry through the lens of a major LNG shipper.
The FLNG Q2 2022 earnings report transcript gives an excellent and revealing insight into LNG shipping issues and where Europe and China (Japan) fit. There is a lot of detail about LNG and shipping costs.
The Q&A section of the call was really interesting as CEO Oystein Kalleklev gave a very revealing response to a question about the timing and ease of switching from LNG to hydrogen shipping, which I address below. It confirmed my gut feel that the current euphoria for hydrogen is a triumphant ploy by the natural gas industry which in no way reflects reality.
The Q3 2022 earnings report expanded on the previous quarter’s discussion. The basics were fine with revenues $91 million (previous guidance $90 million) and 4th quarter will be better ($95-98 million, in line with previous guidance). With strong contract coverage, strong financial performance and healthy cash balance, the quarterly dividend was $0.75/share. Adding in the Q4 dividend, the annual dividend will be $3.50 with an implied yield of ~10%. All of the company’s ships are chartered, with two possibly opening up in 2024 but they have charter extension options. No surprises here. Four ships will be opened up in 2026 and 2027, which is good timing as a lot of LNG is expected to come to market in this time window. Since it costs $250 million to build a new ship, there is expectation that the ships becoming available will be re-contracted possibly on better terms. The company has $271 million cash and expects this number to climb. With no upcoming debt maturities and with CapEx only needed for ordinary dry docking, ongoing dividend payout seems very secure.
CEO Oystein Kalleklev summarised how the company has managed the beginnings of the energy transition and the various financial shocks that have happened since COVID. While the company didn’t predict the Russian invasion of Ukraine, the general conditions, with a lot of free money and an energy shock already on the horizon, meant it doubled down on betting interest rate hikes were coming. FLNG locked in big gains in interest rate swaps and then entered into a further $200 million of interest rate swaps for a decade at 1.7%. The company is well protected from interest rate rises. With the start of the war came energy security issues which helped FLNG’s shipping business. Unlike some of the oil & gas majors, FLNG has a keen appreciation that energy is complex, with major considerations concerning emissions, affordability and security. FLNG management sees the likelihood that Europe will avoid an energy crisis this winter due in no small part to availability of LNG combined with some lucky breaks (eg COVID lockdowns in China resulting in demand destruction, mild weather in Europe so far). There were some interesting statistics on LNG supply and demand. The US is the biggest driver of export with six million additional tons (growing at 11%), but Russia is still growing LNG exports (despite sanctions) by 12% or three million tons; Malaysia exported an extra three million tons (growing at 13%) and there were four million tons from other markets. Unsurprisingly Europe is the key importer, importing essentially all of the growth in the market, leading to shortfalls in the rest of the global markets. With COVID restrictions, China’s LNG imports are down 22% for 2022 (but it looks like this demand is coming back). Other markets (eg Bangladesh, Pakistan, India) are being forced out of LNG by the price. Europe’s LNG imports increased by 37 million tons (57%) in Jan-Oct 2022. Of course the high prices are resulting in a big focus on energy savings, so gas consumption in Europe is down 12%. The upshot is that Europe’s gas storage is essentially full at the start of winter. In summary Europe is probably OK for the upcoming winter, but next year might be different. Indeed currently there are 40 LNG ships tied up and being used as floating storage. This removes a lot of ships from the spot market.
Given the dramatic price rises, there is a big backlog in ship construction and the price of LNG ship construction has increased by $70 million, from $180 million to $250 million. Note that FLNG is not building ships. The value of FLNG’s 13 fuel efficient, fifth generation LNG carriers, has increased by a book value of $900 million in a short period of time!!
In the Q&A there was a question about fleet development. Kalleklev said FLNG is focused on making sure it fully exploits its existing fleet. The big focus is on being able to pay consistent dividends. The point is that a new ship in today’s market ties up capital ($250 million). This could endanger the ability to pay the dividend and the capital would be tied up until the end of 2027. FLNG can cope with an expanded fleet as the platform is scalable to cope with doubling in size without major new staff recruitment. They are open to expanding, but not if it is going to endanger the dividend. The company pays out essentially 100% of their earnings as dividends. This isn’t the oil & gas exploration industry where huge CapEx is part of the game. FLNG has an individual shareholder with a 44% stake. He, John Fredriksen (Norweigan-born Cypriot oil tanker and shipping billionaire), is a key influencer and he likes dividends.
A question about the Asian market with La Nina for a third year, revealed that unlike Europe, Asia has limited storage capacity, so a cold snap would mean immediate demand.
The future, shipping hydrogen?
The above coverage in the Q3 2022 reporting provides an overview for investors. You get a good sense of a solid, stable, high dividend paying company. In the Q2 2022 Q&A there were some interesting questions about the future and in particular the possibility of adapting the fleet for transporting hydrogen. I found this a rare piece of reality which is essentially absent from the hydrogen hype that just about everyone seems to be buying into.
It is always good to hear from an industry insider about a product (hydrogen) that seems logical to be adopted when LNG doesn’t work any more (because the world is decarbonizing). The question was would Flex LNG be able to adapt its fleet to carry hydrogen within five years.
In answering this question about ability to switch from LNG to hydrogen shipping, there were two interesting comments from FLNG CEO Kalleklev. Firstly, the time for a swap-over is a lot longer than five years (simple answer to the question was “no”). A possible reason for the negative answer concerned the temperature that hydrogen needs to be shipped at. The temperature for shipping hydrogen is 90C colder than for LNG (-253C vs -162C). This changes everything (ie a totally different type of ship). It is even more problematic because hydrogen is so small it escapes piping and containment, and hydrogen is extremely flammable!
Kalleklev said there has never been an accident with LNG shipping, but the situation is completely different for hydrogen. It requires very low temperature. The issues are not only leakages and flammability but hydrogen isn’t dense so you need a lot more ships to move the same amount of energy.
On making hydrogen Kalleklev said it is made from gas, which is very inefficient and costly because natural gas isn’t cheap. Green hydrogen is even worse because making hydrogen from renewables is inefficient and completely uneconomical. Kalleklev did mention ammonia as another way to transport hydrogen. Here there are also drawbacks even though it is easier to transport than hydrogen. Ammonia is toxic in terms of corrosion. He was clear that hydrogen is not a go as far as FLNG is concerned.
FLNG’s business is about transporting LNG.
Conclusion
It always helps me as an investor to hear what key market participants think about their industry. I found the perspective of Flex LNG CEO Oystein Kalleklev to be useful in seeing LNG from a perspective rarely discussed. When a leading industry player is reticent to double down and invest at a time of record demand and pricing, helps make clear the challenges that the fossil fuel industry is encountering. Furthermore, caution about an easy transition to hydrogen shipment was a rare piece of caution concerning the status of the “hydrogen industry”. It is hard to see a future for hydrogen without the means to move it around the world and this seemed to be the view of a leading gas shipper.
I’m not a dividend investor as I like investing in change and emerging technologies. However, I acknowledge that there are a lot of Seeking Alpha readers who are dividend investors. FLNG seems like a company that might be of interest. Here is a company that has had solid share price increase (50%) in the past 12 months and which is laser-focused on delivering a high dividend (~10%) to its investors. This is no doubt helped by having an experienced shipping billionaire as a 44% shareholder who loves dividends. Seeking Alpha authors are a bit luke-warm (two buy, two hold), while just two Wall Street Analysts in the past 90 days are divided between hold and buy. The Seeking Alpha Quant rating is much more bullish with a strong buy. I think as long as natural gas/LNG is favoured, this looks like an excellent company for dividend investors. However, I can’t help but think that the reason that Flex LNG is not doubling its fleet at the moment might have something to do with the urgent need to decarbonize energy. It is up to you and your financial advisor as to how you balance these conflicting issues.
I am not a financial advisor but I follow closely the dramatic changes occurring as the end of the fossil fuel industry approaches. I hope that my perspective helps you and your financial advisor as you consider possible investment in FLEX LNG in particular and the LNG industry more generally.
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