Gorgon LNG Deal with China a Really Big Deal

Gorgon, Gorgon, Gorgon! Keep that Gorgon flowing! Keep that Gorgon flowing, Chinaaaa!

Well just a day after highlighting the size and scope of the Gorgon LNG project in Western Australia, we have news that it really is a big deal. It is so big, in fact, that Martin Ferguson, the Federal Minister for Energy and Resources, said Australia is emerging as an "energy superpower."

Shazzam!

Ferguson was in Beijing last night to sign a deal sending $50 billion worth of Gorgon gas to China over the next twenty years. Exxon Mobil will sell the gas to PetroChina and the Australian government will siphon off as much as $40 billion in tax and royalty revenues over the life of the project.

China gets energy. Exxon gets profit. Australia gets jobs and revenue. Investors get a whole new industry to play with.

Mind you, this comes after the Gorgon consortium agreed to sell $25 billion worth of gas to India over the next 20 years as well. The deals are truly flowing. And there could be more. "As well as Gorgon and Woodside, there is the Sunrise project in the Timor Sea," Ferguson says. He's right. In fact, there are four major LNG zones in Australia.

Back in April we wrote this in a weekly update to Diggers and Drillers subscribers, "The other three major areas of LNG development are the Browse Basin (off the Kimberley Coast), Darwin (for LNG from the Timor Sea), and Gladstone in Queensland (the proposed terminal for export of coal-seam-methane projects in the Bowen and Surat basins). Under the Howard Government, Australia had as ambition the production of 60 million tonnes of LNG per year for export (mtpa). The current capacity of the four regions, according to industry analyst David Wood is more like 90mtpa. That would be more than half of current global production of 175mtpa."

Some of those regions are considered "conventional" LNG zones. Others, like the coal-seam-methane district in Queensland, are "unconventional." There are a few small firms operating there that Kris Sayce has been all over at the Australian Small Cap Investigator. Ferguson is excited about these too. "We also have an emerging industry on the east coast -- coal-seam methane. So we now have the opportunity, in my opinion, over the next 12 to 18 months, of getting investments of up to $100bn in the LNG sector."

With all that investment pouring into LNG production, and all those contracts pouring money into corporate and government coffers, you have to wonder what all the fuss about iron ore is over. In dollar terms anyway, it seems like less of a big deal. Aren't Australia and China getting along swimmingly?

For example, yesterday we learned that Andrew Forrest's Fortescue Metals Group will cut iron ore prices by 35% from last year's price in exchange for $7.2 billion in loans to fund expansion of its operations in the Pilbara. We should note that the price cut was negotiated with the China Iron and Steel Association (CISA) and that the loans will come from Chinese banks.

What gives? It's not likely that Fortescue's agreed price cut of 35% from last year's benchmark price (which is just two percent larger than what BHP and Rio have already agreed to with Japanese and Korean customers) is going to influence the negotiations between Rio Tinto and the CISA. But that seems to be the message behind the deal: you play nice with us and we'll loan money to you.

Fortescue has agreed to sell 20 million tonnes of ore over the next six months at the discounted price. Keep in mind that annual seaborne iron ore trade is closer to 400 million tonnes a year. It is a big deal. But not a huge deal, certainly not the sort of deal that would bring down the spot price of iron ore, which at over $110/tonne, is higher than the target benchmark price being sought by Chinese firms.

In any event, it looks to us like pricing power in the iron ore business is moving toward a new equilibrium. The annual price negotiations in which the ore producers are represented by one party (that can be squeezed by Chinese political machinations) and the steel makers are represented by another party (in this case, the CSIA, which seems to have made a meal of it) will be replaced.

But with what? BHP wants a benchmark index. China, seeking price certainty and the control a large customer expects to have, resists.

Whatever happens, we're beginning to think that energy exports will matter a lot more to Australian bottom lines than iron ore exports. Of course BHP and Rio are large diversified miners and employers. Troubled relations with China for to the two largest miners by market cap on the ASX are not good for investors.

But what is good for investors is the LNG boom. The big risk, as with any commodity, is that increased demand leads to over-supply. But that is not something we're worried about just yet. These projects take years to develop and secure permitting. Just in time LNG doesn't exist.

That means the firms with the biggest head start and the best prospective areas are going to be worth punting on. At least that's the idea anyway.

But while we're at it, let's report that at least one major investment bank is predicting a second commodity boom driven by a shortage of capital spending and resurgent demand. You always wonder if Goldman Sachs is just talking its own book because it's already made its bets in the sector. But for what it's worth, Goldman is predicting another commodity boom.

"We expect a commodity supply shortage in 2010," a company report proclaimed recently. "We have long emphasized that the commodity problem is, at heart, a supply shortage due to decades of suboptimal investment, which has been exacerbated over the past year by the sharp drop in prices and tight credit conditions. As the commodity markets rebound with the broader global economy we expect a redux of 2008 when severe supply constraints forced the rationing of demand through sharply higher prices to keep the markets balanced."

Goldman argues that the, " imbalances have actually worsened owing to the sharp drops in prices and tight credit conditions that have further impeded investment. In this context, it is important to emphasize that the commodity crisis is, at heart, a supply shortage. Although emerging market demand growth has been strong, the structural rise in prices that has been a key feature of commodity markets for the past several years would not have occurred if supply were sufficient. In reality, trend demand growth for many commodities has been slowing due to supply constraints that are restricting overall demand growth despite robust emerging market demand growth."

Goldman's note goes on to recommend a handful of blue-chip firms that will benefit from higher demand growth. Firms like Cairn India, Cameron (US), CNOOC (China), Hess (USA), Peterobras (Brazil), Suncor Energy (Candada), and more. For Aussie investors, there are a smaller number of energy blue chips and a larger number of excellent speculations.

Dan Denning
for The Daily Reckoning Australia

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