Likely Winners From The U.S./China Deal - In Alaska

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Includes: BACHF, BP, CEO, COP, LNG, PTR, SNP, XOM
by: Tokyo Picker

Summary

China has committed to large increases in purchases of US goods and services.

An easy way to achieve this is to increase Chinese purchases of US LNG and to leverage Chinese state financial power.

Among the first beneficiaries are likely to be the owners of Alaskan gas.

On May 19, the US and China announced that China, in response to pressure from the Trump Administration, had agreed to buy significantly more US goods and services, including "meaningful increases" in US energy and agricultural exports.

While no precise figure for the total package was announced - the description merely said "significantly" increase - Larry Kudlow, director of the National Economic Council, indicated shortly before the announcement that the Chinese offer was close to the White House target of $200 billion annually.

So what can the Chinese quickly and easily do to make a start on this change without significant conflict with their existing policies and objectives? Pollution points the way.

China's Coal Problem

China's cities have had some of the worst air pollution in the world and the Chinese government has responded with multiple schemes to fix that:

Source: Ministry of Environmental Protection of China The major culprit in the air pollution afflicting China has been that country's massive increase in coal burning over the last few decades.

China coal usage The coal has produced most of the particulate contamination in the air:

Source: Atmospheric Chemistry and Physics While China is working on a number of solutions and litigants to the coal problem, one of the most important is the switch to gas.

China's gas supplies

China is a substantial producer of gas, producing approximately 150 billion cubic meters per year, and, according to the CIA, has the 10th largest proven gas reserves in the world - approximately 5.2 trillion cubic meters. However, domestic production is unable to meet the huge demand unleashed by the anti-pollution programs.

Chinese LNG production shortfall The state-owned China National Petroleum Corporation estimates 2018 demand at 260 billion cubic meters. The difference is met by imports, and those imports have been increasing quickly, with China recently overtaking Korea to become the second largest importer of liquefied natural gas (LNG).

Source: EIA Furthermore, Chinese use of gas is still low by the standards of developed countries and so there is a lot of room for further growth.

Where are the imports coming from?

Although China has an expanding number off pipelines bringing gas from central Asia (Turkmenistan, Kazakhstan and Russia) and from Myanmar, these sources are far from China's population centers on its Eastern seaboard.

Due to this, more than half of China's gas imports come by sea, in the form of LNG and that proportion is growing.

China's LNG import sources are and have been highly diversified.

It is important to note that, while China has a number of long-term LNG supply contracts in place, a surprisingly large proportion of Chinese imports are purchased on short-term, spot market contracts.

How will China's LNG imports be affected by the US/China trade deal?

The US has exported substantial amounts of LNG to China over the last couple of years, but there is a lot of room for growth. During the negotiation with China, the Trump Administration, particularly in the person of Commerce Secretary Wilbur Ross, has been prioritizing LNG exports. Clearly China has the intention and the capacity to substantially increase LNG imports and it is the administration's intention that the US should be the provider of much of the additional supply. The reader should remember that, although China has begun to allow private participation in LNG imports, the industry is still state dominated, primarily by three state controlled corporations - Sinopec (aka China Petrochemical Corporation) (SNP), PetroChina (PTR), and CNOOC (CEO), which between them control 17 of China's 18 LNG import terminals.

Until now, there has only been one long-term supply contract finalized with a US supplier - the February contract with Cheniere Energy (NYSEMKT:LNG). However, there have been a number of framework agreements for further supplies, including most notably an agreement on the Alaska LNG project between the state of Alaska, Alaska Gasline Development Corp., owned by the state of Alaska, Sinopec (SNP), the Bank of China (OTCPK:BACHF), another state controlled entity, and the CIC Capital Corporation, China's sovereign wealth fund, which provides for development of a cross-Alaska pipeline and a new LNG export terminal at Nikiski on the Alaskan coast - due to the expiration of the export license at Andeavor's (NYSE:ANDV) nearby Kenai terminal that would be the only export terminal on the US western seaboard. This agreement was signed in November in Beijing in the presence of Presidents Trump & Xi.

Alaska LNG

The Alaska LNG project began in 2014 as a joint effort between the state of Alaska and the three major resource owners on Alaska's north slope - BP (BP), Exxon Mobil (XOM) and ConocoPhillips (COP). The north slope fields contain almost one trillion cubic meters of proven reserves and another 5.66 trillion cubic meters of potential reserves, concentrated primarily in the Prudhoe Bay field (operated by BP) and to a lesser extent in the Point Thomson field (operated by Exxon Mobil). However, due to the remoteness those fields, the assets had been viewed as effectively stranded for commercial reasons. The efforts failed the grounds of the huge ($45 - 65 billion) costs of the project and in 2016 the commercial partners gave up.

The Alaska government did not give up but continued seeking new partners. The effort continued from the Parnell administration into the Walker administration. If the project goes ahead it will be one of the largest infrastructure projects ever undertaken in the US and a huge provider of jobs for blue collar workers. For comparison, 70,000 people are estimated to have worked on construction of the trans-Alaska oil pipeline in the 1970s.

The Chinese involvement is a game changer. Although the November agreement was effectively a non-binding expression of interest, the Chinese specified that they are interested in taking 75% of the project's output. The inclusion of the Bank of China and the China Investment Corporation were to show their interest in providing a substantial part of the financing. Furthermore, they have set May 31 as the target date to produce more concrete and detailed agreements on construction and financing. As a consequence, AGDC has appointed Bank of China and Goldman Sachs (NYSE:GS) to arrange financing for the project, BP signed, on May 4, an in-principle agreement to sell gas to AGDC, including price and volume targets, and AGDC has begun soliciting off-take agreements for the other 25% of output from other Asian purchasers, including in Japan, Korea and Vietnam.

The agreement suggests that the project may be completed in three phases, each with a capacity of about 6.7 million tons pa. According to the Japanese Ministry of Economy, Trade and Industry, Asian spot prices for LNG are approximately $9/MMBtu. Estimating about $1/MMBtu for shipping, source here, gives us an annual revenue of approximately $2.65 billion pa for each stage.

Depending on the progress of federal and state approvals, construction is anticipated to start in late 2019 or early 2020, and be well under way by the 2020 election.

Conclusion

China needs and wants a lot more gas and the Chinese state has effectively full control over where and from whom they buy it. The Chinese also want to avoid a trade war with the US.

The US administration wants China to buy a lot more energy from the US, wants large, high profile infrastructure deals

In my view it is very unlikely that China and the US would have announced their trade deal, with specific mention of energy, and with the substantial personal and political commitments of both Presidents and Secretary Ross, without certainty that the Chinese parties are going to proceed with the Alaskan project.

From the Chinese point of view, it is a simple and immediate commitment that they can make without reference to non-governmental players. Their downside is probably limited - they may have to accept sub-par returns for their state-owned financial institutions - and there may be some upside - the new US supply will put downward pressure on prices from their other suppliers such as the Qataris and the Australians.

From the US point of view, it will be a highly visible and tangible victory for the administration's trade policy - expect to see campaign commercials filmed on the construction sites and interviews with the construction workers.

And the incidental - but very happy - beneficiaries of this confluence of political interest - BP, Exxon Mobil and ConocoPhillips, who will see a stranded asset suddenly become very realizable.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in BP, COP, XOM over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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