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Energy Transfer: Potential Energy Trade Of The Decade



Energy Transfer (NYSE:ET) has been one of the biggest beneficiaries of the commodities bull run of 2022 as its units outperformed the S&P 500 while the successful performance of its business thanks to the increase of energy prices made it possible for the management to distribute more cash to the unit holders. At the same time, there are reasons to believe that the company is likely to retain its momentum in the following years as the tight supply along with a relatively high demand for natural gas around the globe are making it possible for Energy Transfer to continue to generate aggressive returns and create additional value along the way.

There Are Reasons For Optimism

Energy Transfer units appreciated by ~10% since my latest article on the company was published in December and there are reasons to believe that there’s more room for growth. Even though the company’s revenue decreased by 29.3% Y/Y to $18.32 billion in Q2, the reduction was caused primarily due to the price weakness in the natural gas market which affected all of the companies from the industry. Despite such a reduction in revenues, Energy Transfer’s fractionation and transportation volumes in Q2 increased by 5% and 13% Y/Y, respectively, and set new records for the company.

At the same time, despite the price weakness, Energy Transfer’s adjusted EBITDA in Q2 was $3.12 billion, just slightly below the $3.23 billion from a year ago, which indicates that the business has been able to successfully adapt to the new environment without suffering significant losses. Thanks to this, Energy Transfer was able to distribute $1.55 billion in cash distribution to its unit holders in Q2 alone.

Going forward, there are even more reasons for optimism. First of all, the overall improvement of the American economy in recent quarters indicates that a hard landing that could’ve destroyed the demand for natural gas even more is no longer in play. This should help Energy Transfer to continue to increase its volumes as the market normalizes.

What’s more is that Russian natural gas is not returning en masse to the international markets, which is good news for non-Russian natural gas producers and all the other businesses from the industry. By the end of 2022, Russian gas supplies accounted for less than 13% of supplies to the European Union, down from 41% in 2021. This was possible thanks to the increase in supplies of American LNG to the old continent which now provides 50% of the European LNG demand.

Add to all of this the fact that Russia won’t be able to redirect its natural gas supplies to Asia in the same volumes in the following decades and it becomes obvious that the supply would remain tight while the demand is likely to increase thanks to the projected growth of the global economy. This is one of the main reasons why the IEA believes that Asian spot LNG and TTF prices are expected to remain above their historic averages this year. That’s why there are reasons to believe that Energy Transfer volumes would continue to increase and set new records as a combination of domestic and global developments would keep the natural gas flowing through its pipelines.

Considering all of this, it seems that at this stage there’s nothing not to like about Energy Transfer. At the current price, Energy Transfer offers an attractive forward yield of over 9% and it expects its adjusted EBITDA for FY23 to range between$13.1 billion and $13.4 billion. On top of that, back in December, I noted that its units represent an upside of ~40%. Considering that they already appreciated by ~10% since that time, there’s still around 30% upside left. This view is shared by the street as well as the current consensus price target for Energy Transfer is $17.28 per unit.

Energy Transfer’s Consensus Price Target (Seeking Alpha)

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Two Risks To Consider

I see two major risks that could undermine the bullish thesis. The first risk would be the inability of Energy Transfer to construct the Lake Charles export LNG facility and miss on global opportunities that the market offers. So far, the company signed deals to supply 7.9 million metric tons of natural gas per year to clients primarily from Asia, but it still hasn’t reached a final investment decision on whether the construct the facility in the first place.

Earlier this week the management requested the U.S. Department of Energy to give the company a new export license for the facility as it won’t be able to complete the project under the current license with a deadline in 2025. Considering that the request to extend the current license failed earlier his year and there’s no guarantee that the new licensee would be issued at a time when others are already finishing the building of their export LNG facilities, there’s a risk that Energy Transfer would miss the ability to monetize global opportunities.

Another risk to Energy Transfer’s bullish thesis is the return of Russian natural gas to international markets en masse, which would lead to an extended period of price weakness in the natural gas market and undermine the company’s growth story. We already see how the Russian LNG slowly replaces the pipeline gas in Europe and Asia and poses a threat to American producers and midstream service providers. The good news though is that this risk is unlikely to greatly materialize in the following years as the Russian LNG is unlikely to reach the same export levels as the pipeline gas had before Russia’s invasion of Ukraine.

The Bottom Line

While there are certain risks to Energy Transfer’s growth story, the company has more than enough catalysts that could help it overcome any potential downsides. Add to all of this the fact that the current geopolitical environment favors non-Russian natural gas businesses, and it becomes obvious that Energy Transfer has everything going for it to generate decent returns in the future.

At the same time, even if it decides not to proceed with expanding its Lake Charles LNG project, it will still have more than enough options to continue to create additional value for years to come. But if it decides to enter the export business and finish the export LNG terminal before the deadline, then its opportunities to create value would only expand further. That’s why there’s nothing not to like about Energy Transfer at this stage.

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// UPDATED ON 21/09
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