Mind the Spread – Thoughts from the 2013 High Horsepower Summit
Earlier this week I was in Chicago for the 2013 Natural Gas for High Horsepower Applications Summit. Overall , it was a very well done conference with some very good panels and excellent companies represented. It’s a testament to the growth (in interest at least) in finding new uses for natural gas (NG) that the conference attendance jumped from 400 people last year to over 1,300 attendees this year.
As I sat through 3 days of panels that covered the use of NG in rail, marine, pressure pumping, drilling and mining operations, there was one word that kept coming up over and over again – the “spread”. The “spread” is the pricing delta between delivered NG and the diesel fuel (or marine equivalent). With diesel prices high and US NG prices low, the “spread” is large enough that using NG can save 20–30% of your fuels costs. If you are a heavy fuel user – like the high horsepower applications – that savings can have a tremendous impact on your bottom line and corporate valuation.
Let’s look at an example to see how impactful that switch can be. In FY11, the US Class 1 railroad CSX Corp spent $1.688 billion on diesel fuel at an average price per gallon of $3.18. That’s approximately, 530.1 million gallons of diesel fuel purchased and consumed to power their 4,192 locomotives – 126,626 gallons per locomotive. If 50% of those locomotives were to convert to LNG, CSX would replace 265.4 million gallons of diesel with LNG. If we take a conservative approach and say that LNG provides a 20% savings over diesel, that would be $0.64 per gallon on 265.4 million gallons, or $168.8 million PER YEAR. That amount flows straight through to the bottom line each and every year! At CSX’s current +/–15 PE ratio, that increases shareholder value (corporate valuation) by over $1.1 billion. You can see why the railroads are so interested in fueling their fleet with LNG.
[This analysis is not intended to be a commentary on CSX’s intentions to utilize LNG. As far as I could tell, they were not an exhibitor at the HHP Summit, nor were they active panelists. Frankly, I chose to pick on them for this analysis because there’s a CSX coal train that runs down by the river at my house that greets me every morning at 5am. Nothing more should be construed from their inclusion here.]
A word of caution: While the valuation exercise works in today’s market and “the spread” is there to justify using LNG, that may not always be the case. The US is aggressively looking for international markets where it can export its no abundant supply of NG. Increasing the usage and demand for the commodity, domestically and abroad, will necessarily result in some increase in the commodity price. That’s why they do it! How much the price increases is unknown at this point. But, the idea that it will increase to some degree is widely accepted.
On the flip side, the price of diesel fuel may come down in response to a decrease in demand. If more users (like CSX) go the NG route, that will decrease the demand for diesel, reduce its price and further narrow “the spread”. Again, how much the price may fall is tough to determine. There’s also the possibility that OPEC instigates a meaningful response to the global NG threat and lowers the price of its oil to intentionally narrow “the spread” and slow the adoption of NG. However, predicting the actions of OPEC is well above my pay grade…
For now at least, “the spread” remains intact and means there’s an economically compelling reason to make the switch to NG. How that “spread” holds up is yet to be seen.
I will say I was a little disappointed at the role the environment played at the HHP Summit. This is grossly overstating it, but it was only in the marine sessions (who are contending with ECA requirements) that the idea of an environmental benefit was discussed. The use of NG has so many NOx, SOx, PM and GHG benefits that this aspect should get more attention in the US. Internationally, where the “spread” is much smaller or doesn’t exist the environment has been the key driver of NG adoption. However, the nascent US industry is in a “show me the money” phase of its development.