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LNG Boom Down Under Fuels Heavy Construction

A liquified natural gas blitz was already under way in northwest Australia when, in January, Japan's Inpex and French energy giant Total (NYSE:TOT - News) launched a $34 billion project named Ichthys.

The undertaking requires a 500-mile subsea pipeline from offshore natural gas fields to Darwin, a city in northwest Australia. There, refrigeration trains will liquefy the gas for export via frosty LNG tankers.

Other projects in Australia's LNG buildup include Chevron's (NYSE:CVX - News) $43 billion Gorgon LNG operation. Australian gas leader Santos is investing $16 billion in its Gladstone LNG export project. U.K.-based BG Group has begun to shop for partners to expand its $15 billion Curtis Island project, the first LNG project to liquefy gas produced from coal seams for export to global markets.

All told, Australia has $200 billion in LNG construction underway and is expected to reach parity with Qatar, the world's top LNG exporter, by 2017. Other LNG development projects are underway in Russia, the U.S., the Middle East and Canada.

Who's buying the gas? China, for one, which is struggling to keep up with its energy demands and tamp down emissions from its vast fleets of coal plants and diesel-fired generators. Japan is also cranking up its fuel demand. The country has idled 51 of its 54 nuclear facilities — 25% of its generation capacity — since the tsunami-triggered meltdown of the Fukushima Daiichi reactor a year ago.

The country plans to make up much of the difference with natural gas, the vast majority of which must be shipped in as LNG.

"The world is signaling that it needs more natural gas delivered," said analyst Michael Dudas with Sterne Agee. "And many of the natural gas deposits around the world are located in places where you can't really connect the pipe.

The result has been a boon to global energy contractors led by Fluor (NYSE:FLR - News), KBR (NYSE:KBR - News), Jacobs Engineering (NYSE:JEC - News) and Chicago Bridge & Iron (NYSE:CBI - News). The engineering and construction firms, part of IBD's Building-Heavy Construction industry group, are all deeply involved in LNG and other energy construction projects. Stocks in the group have been recovering from October lows, lifting the group into IBD's top 50 rankings of industries over the past month, after starting the year ranked at No. 119.

1. Business Typically called EPCs — engineering, procurement and construction firms — these companies handle many of the world's most complex building projects: nuclear power facilities, highways, government military contracts, refineries and pharmaceutical plants.

They compete for front-end engineering and design (FEED) contracts, which give them access to the early stages of a project, meaning high-margin phases that involve design and estimating project costs. Once a project is approved, the companies jockey for contracts to locate and hire workers, design and procure equipment, materials and components, and to manage the actual construction.

The largest player in the sector is privately-owned Bechtel, based in San Francisco. With nearly 53,000 employees, it reported more than $27 billion in revenue in 2010. Among the publicly held players, Fluor is the big cat, with $23.4 billion in 2011 revenue. Next in line is Jacobs, with revenue of $10.4 billion last year. KBR and URS (NYSE:URS - News) both reported a little more than $9 billion in annual revenue.

Companies within the industry are in a semi-constant state of consolidation. KBR, for example, formed as the Kellogg, Brown & Root subsidiary of Halliburton (NYSE:HAL - News) when the oilfield services giant acquired Dresser Industries in 1998. Halliburton then spun off KBR in 2006.

The group's leading stock, Chicago Bridge & Iron, sold to Connecticut-based Praxair (NYSE:PX - News) in 1997. Praxair carved out the Liquid Carbonic subsidiary, which manufactures carbon dioxide for soft drinks, then sold the company to a group of Dutch investors. Now based in the Netherlands, CB&I last year saw more than 75% of its revenue from outside the U.S.

Name of the game: Maintain a sterling reputation for innovative engineering, tight-tolerance construction standards and executing on time and on budget.

2. Market The U.S. saw a buildup of LNG import facilities following the natural gas price spike in 2000. The shale gas revolution then rose and turned gas prices around, giving U.S. gas a significant price advantage on global markets.

But while the global push to move LNG to hungry markets has been strong, the U.S. still has only one LNG export facility, in Kenai, Alaska.

Three export facilities have been approved in the lower 48 — in Freeport, Texas; Sabine, La.; and Hackberry, La. Other applications are pending, hinting that spending on LNG export projects may have yet to really take hold in the U.S.

The engineering firms in the heavy construction group will benefit to varying degrees.

"They all have different areas and levels of particular expertise," said John Rogers, analyst with D.A. Davidson.

KBR and Chicago Bridge & Iron tend to benefit most from LNG projects. Fluor designs and builds LNG facilities as well. But it is also a leading contractor to the global mining industry, developing mining sites for clients including BHP Billiton (NYSE:BHP - News), Rio Tinto (NYSE:RIO - News) and Barrick Gold (NYSE:ABX - News).

Fluor is also a leading player in power utility projects, another busy sector recently. Researcher Bentek Energy reports the U.S. will see a total of 35 new, gas-fired power plants with capacity of 12.5 gigawatts come online in 2012 and 2013, as power producers scramble to tap lower natural gas prices and stay ahead of federal emissions rules.

3. Climate Across the industry, companies face an increasingly competitive global economy. Clients are demanding that engineering companies find ways to lower project costs. At the same time, many are also requiring more "local content," meaning skilled labor hired in-country.

Those pressures are driving engineering firms to more dispersed models, as well as more strategic alliances. KBR's joint venture with AMCDE (Abdulla Al-Moaibed Consulting & Design Engineering) in Saudi Arabia recently earned preferred provider status from national oil company Saudi Aramco. KBR expects the unit to generate $70 million to $100 million a year in revenue.

At the same time, KBR has seen revenue decline since 2009 as its contract work for the U.S. military in Iraq winds down. While the work provided strong cash flow, it was narrow margin territory, Dudas said. As a result, KBR's earnings bounced 52% higher last year despite its 8% decline in revenue.

Dudas expects that trend to continue for KBR. He sees the company leaning harder on Kellogg's energy industry roots, while de-emphasizing the military legacy of Brown & Root.

"The K is overtaking the BR as we move through the cycle," Dudas said.

CB&I has expanded its breadth within the LNG construction process. A specialist in storage tank construction since the U.S. railroad buildout in the 1800s, CB&I has expanded into design and construction roles in import facilities, export tank facilities and liquefaction facilities.

"They were able to leverage their international relationships and expertise in order to take on bigger roles within projects," said Rogers, who owns CBI shares. "The projects have gotten bigger and more complicated, so the customers want that.

4. Technology Japan's move away from nuclear power has been a leading driver of the global LNG buildup. But in the U.S., nuclear power still produces a steady 20% of electrical needs. In October, Fluor quietly took a majority stake in NuScale Power, an Oregon operation focused on a new breed of small-scale nuclear reactors.

Fluor invested a modest $3 million and pledged $30 million to move the technology forward.

Rather than the large, concrete cooling towers usually associated with nuclear plants, NuScale's units are steel cylinders measuring 65 feet by 14 feet. The design combines steam generator and reactor units, and it employs convection currents rather than mechanical pumps to circulate and transfer the heat energy.

Such so-called "light-water reactors" don't aim to replace full-scale nuclear facilities, which range from 478 megawatts to more than 4200 MW in the U.S.

NuScale's units can generate 45 MW of power. As many as 12 units can be linked at a single location. The idea is to allow what the company argues is safer, and more distributed nuclear generation, appropriate to smaller towns or individual corporate sites.

The Fluor-NuScale venture faces hefty competition. Nuclear construction specialist Babcock & Wilcox (NYSE:BWC - News) owns mPower, which touts plans for compact, 18 MW light-water reactors. Hyperion Power Generation is also considered a contender, offering a 70 MW design. In addition, Bechtel and Babcock & Wilcox announced a joint venture in 2010 aimed at building portable mPower generators for export.

5. Outlook Globally, Dudas sees LNG spending still on the upswing, probably at a midpoint.

He said: "I do think that the investment will continue at a pretty reasonable pace, at least from a buildout standpoint, over the next five years.

In the U.S., spending on heavy construction projects was flat last year at about $266 billion. But spending on power-related projects rose 14%, climbing in nine of the ten months through December, to $89.5 billion for the year. Nearly 70% of that went to projects related to electricity generation and transmission.

Bernard Markstein, chief economist with Reed Construction Data, forecasts a 9% increase in total construction spending for 2012. Markstein predicts that spending on power-related projects will jump 20%, then taper significantly in 2013.

Upside: KBR president and chief executive William Utt sees electrical power becoming an even brighter part of the engineering and construction picture.

"Recent clarification of the (federal power-generation emissions) rules, as well as the judicial stay of the cease-fire rules, should give rise to an increase in air-quality control projects in 2012 and 2013," he said in a Q4 conference call. Announced retirements of some coal-fired power plants are likely to spur additional construction of new gas-fired, combined-cycle power plants.

Risks: Rising demand and any complications with supply could force natural gas prices higher and reconfigure global LNG flows. A messy default by Greece could weigh on Europe's economic prospect, and many analysts argue that China is overdue for a hard economic downturn. Either could significantly alter the capital spending posture of the engineering and construction industry's leaders.