Liquid natural gas China’s salvation?

by Levi Folk | April 19, 2008

The ability to turn natural gas into liquid form for easy transportation is an important development for China over the next several decades. The country relies on coal for most of its electricity production, with devastating consequences for the environment.

China is already recognizing its need to secure supplies of clean energy over the next several decades and has started buying liquid natural gas (LNG) production several years forward. Investors should get in early on this trend and invest in LNG producers. Woodside Petroleum Ltd. (WPL/AUS) in Australia is highly leveraged to this opportunity.

China will have no choice but to find cleaner sources of energy supplies over the next several decades because environmental concerns will force its hand. The country’s industrialization is “an economic disaster” according to Elizabeth Economy writing in Foreign Affairs magazine.1

Currently China derives 70% of its energy production from coal—2.4 billion tons in 2006 to be exact—more than the U.S., U.K. and Japan combined. Sixteen of the 20 most polluted cities of the world are in China. Coal is responsible for roughly 90% of China’s sulfur dioxide emissions and 50% of its particulate emissions.

According to a 2007 report from the Netherlands Environmental Assessment Agency, it has already surpassed the United States as the world’s largest contributor of carbon dioxide, a leading greenhouse gas, to the atmosphere.

China’s government has promised to reduce pollution by encouraging alternatives to coal, and has set targets and dates. An important caveat here is that past targets have not been met.
Nevertheless, liquid natural gas will figure in a solution, playing a small but significant part from an investment point of view given its current small production base.

There are currently roughly 30 LNG plants around the world producing about 180 million tonnes per year (mtpa). Demand for LNG will grow to around 380 mtpa by 2015, and demand is expected to outstrip supply, based on current projects under construction and those probable for start, according to industry analyst Wood Mackenzie.

Woodside Petroleum is an Australian energy producer with perhaps the greatest leverage to the LNG industry over the next decade. Woodside stands to become the "the fourth largest nonstate-owned LNG equity producer in the world" by 2015, according to the company’s 2007 annual report, and number one in the world in terms of operated LNG liquefaction capacity.

Recent deals made by Woodside for LNG point the way forward for LNG demand. It recently signed separate agreements with PetroChina and CPC Corporation of Taiwan for two to three million tonnes of LNG each over 15 to 20 years from the company’s Browse LNG project, beginning 2013 to 2015.

Woodside presents an interesting opportunity for investors over the long term for several reasons, proximity to China being an obvious one.

Russia has the world’s largest gas reserves but has failed to develop those reserves sufficiently due to a lack of capital spending.

Political risk in Australia is also low, which makes it attractive in an environment where oil assets are being nationalized and under heavy threat of taxation around the globe

Last year was not a good year for Woodside from an operational perspective. The company reported a 28% drop in profit over 2006 and lowered its production guidance several times throughout the year.

It has been bitten by a stronger currency and higher expenses and has raised doubt among analysts and investors about its ability to meet its production targets. These issues are likely to result in more conservative production estimates, and are likely an opportunity for long-term investors with a grasp of China’s energy demands.