Commodities are rarely associated with explosive consumption growth. While the rise of China challenged this notion, the best days of the super-cycle in materials are clearly behind us. For example, over the past three years the world’s consumption of copper rose just 0.6% per annum, and it is unlikely to expand much beyond this rate. However, there is one commodity which we are excited about for the next 10 years, one where the super-cycle has only recently announced itself ̶ liquefied natural gas (LNG). The LNG market has been in the doldrums for some time. Between 2011 and 2016, total global consumption rose by just 17 million tons. But over the course of 2017 and 2018, demand skyrocketed by 63 million tons. The size of the global LNG market stood at 320 million tons last year, and we expect it to roughly double by the end of the next decade.
Exhibit 1: Demand for LNG has skyrocketed, and it could continue to soar
Two major structural shifts are happening at the moment: the
globalization of natural gas – traditionally a local or, at best, regional
commodity – and the political will in China and elsewhere in Asia to secure
affordable, reliable, and clean energy. Natural gas has long been viewed as the
“fuel of choice,” a privilege confined either to producing countries like
Russia and the United States, or to the domain of the economically developed,
like Europe or Japan. This old world view is now collapsing. Earlier last year,
China became the largest importer of natural gas, overtaking Japan. LNG
specifically is becoming the “fuel of necessity,” and the growth from here will
be driven by China, other Asia ex-Japan countries, and eventually India. Our
meetings with policymakers in China reconfirmed this outlook: fostering a
healthy environment is being viewed as critical to maintaining social
stability, and nurturing gas consumption, as well as finding substitution for
low quality, are integral to both.
The supply-side is shifting as well. Qatar, which accounted
for nearly a third of the market in 2016, will likely be temporarily overtaken
by Australia next year. The United States, irrelevant on the LNG map until
three years ago, could account for one-sixth of global LNG production as soon
as 2020. Finally, Russia will challenge all three contenders for the LNG
throne, securing at least one-tenth of the market by the middle of the next
decade, and a credible chance to become the “next Qatar” in the long run.
Exhibit 2: Russia and the U.S. could emerge as much more prominent LNG suppliers
The narrative becomes much more powerful considering that the LNG market may begin tightening in 2020 and could move into deficit early in the next decade. We believe the world will need more liquefied gas than is currently being sanctioned by the energy companies, which under-invested in LNG during the oil price debacle of 2014-2016. The energy companies lack a sufficient quantity of viable projects and are using their cash flow to channel dividends to their still wounded shareholders rather than invest.
Exhibit 3: Within four years, global demand could begin to exceed supply
So, the race is on. The question is how to invest in such a
powerful and structurally durable theme in an emerging market context? This is
where the challenges begin. First, it is hard to find pure exposure outside of
the United States. (It can now be found mainly with the tolling companies
rather than with the integrated gas producers.) Second, the credibility of the major
energy companies is extremely low. Wood Mackenzie, one of the leading research
and consulting firms for the energy industry, recently estimated that during
the last decade, “The 15 largest offshore projects were late and collectively
$80 billion over budget.” Finally, we remain highly skeptical of the
risk-reward profile in the next generation LNG provinces such as Mozambique.
Hence our approach to investing in commodity companies is really no different from our approach with any other sector. We look for companies with a unique and scalable asset base, management/owners who are culturally inclined to consistently create value, and stock valuations that, for some temporary reasons, reflect neither of these strengths. Our search has been global, but we believe one of the most promising opportunities is Novatek, a Russian-listed private gas company. While the entire industry was suffering from a lack of capital discipline, Novatek launched its first and the world’s largest (non-government owned) LNG project – Yamal LNG – at the end of 2017. It did so on time, on budget, and in the harshest environmental conditions imaginable (the Russian Arctic). It is estimated that it will be bigger in size than the infamous Australian Gorgon (Chevron) and built with less than half of the price tag.
Exhibit 4: Novatek’s earnings have far exceeded the industry average
Many of the firm’s future projects, in our view, will enhance its strengths. Novatek’s long-term strategy is to increase its LNG production capacity target to 70 million tons per year by 2030, up from a previous target of 57 million. Hence we were not surprised last year when the French oil and gas company Total SA had acquired a stake in its second future project (Arctic LNG-2) at a valuation of more than half of Novatek’s market capitalization. In May this year, Novatek announced that its third major LNG plant in the Yamal-Nenets Autonomous District will be launched in 2022 (Obsky LNG). Given the Russian government’s focus on developing LNG, and what we perceive as Novatek’s flawless execution over its 24-year history, and its strong partners like Total and China’s CNPC, we see a bright future for this company.
Blog header image: Nikitje / Getty Images
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As of 9/30/19, Novatek represented 4.84% of Invesco Oppenheimer Developing Markets Fund’s holdings. It should not be assumed that an investment in the securities identified was or will be profitable.
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