Is BP’s $20 Billion LNG Deal the Right Move?

BP plc (NYSE: BP  )  recently entered into an agreement to supply 1.5 million tonnes of liquefied natural gas over 20 years to China National Offshore Oil Corporation. This deal is expected to generate $20 billion for BP. It will also expand its exposure to China's energy market and also augment its revenue in the coming years from LNG. What are the main opportunities and challenges this deal entails for BP?

China's growing demand for LNG
In Asia, China isn't a leading importer of LNG as both Japan and South Korea lead the charge in this front. Moreover, LNG accounts for only 5% of China's total energy demand. But this may change in the coming years: According to the U.S. Energy Information Administration, China's government plans to increase the share of natural gas out of total energy consumption to 8% in 2015 and 10% by 2020. This higher demand for natural gas is likely to come not only from exploration and production of shale gas in China but also from higher imports.

For BP, this deal was its first long term LNG agreement with China and based on the expected rise in demand for natural gas in this country, BP may enter into additional LNG contracts.

The LNG will come from the US Freeport LNG project. BP signed in 2013 an LNG contract for 20 years for 4.4 million tonnes per year. This means, the BP-China deal will account for 34% of BP's LNG contract from Freeport. This deal, however, will only come to fruition by 2019.

In the meantime, other LNG exporters such as Cheniere Energy (NYSEMKT: LNG  ) will enter the LNG exporting business. Cheniere Energy's first two trains from Sabine Pass Liquefaction are expected to start operating in late 2015.

But the expected rise in demand for LNG in China could result in BP reaching additional future contacts for the rest of BP's expected supply of LNG in five years from now. 

LNG prices
But the main concern over BP's deal and any future deals of this sort is related to the price of LNG. The recent deal China struck with Russia to receive LNG from Eastern Siberia could pressure down the prices of LNG in Asia in general and China in particular. According the some estimates, spot LNG prices in Northeast Asia dropped to their lowest level since October 2012. These prices could come further down if Russia increases its supply of LNG to China and thus loosening up the LNG market.

Since in most long term LNG contracts the price is linked to the prevailing market prices at the time of the delivery, BP's expected return and profit margin on this deal could be lower than expected if LNG prices in China further come down.

Final note
This deal puts BP in the right direction by tapping into China's growing demand for LNG. But the potential drop in prices of LNG in the coming years could make this deal, in hindsight, less attractive.

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Lior Cohen

Lior has been a contributor for the Fool since 2012. His main interests are in commodities, and energy and materials companies.You can follow him on Twitter to stay up to date with his industry analysis. @tradingnrg

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