Being two of the largest emerging markets and the top BRIC kingpins, Russia and China had plenty of reason to come together to strengthen their economic ties. And its only natural that the key to that economic cooperation would focus on energy.
As China’s Dragon-sized economy has continued to grow, its energy usage has surged. Overall, the emerging market has become world’s largest energy consumer, surpassing the United States back in 2010. More importantly, China will see its energy demand surge to 220 quadrillion BTUs by the time 2040 hits.
On the flip-side, Russia has some of the world’s largest reserves of oil and natural gas, all conveniently located right next door to energy-hungry China. The problem has only ever been a matter of price.
Well, it seems like the two BRICs have finally come to an agreement on natural gas exports and have created one heck of a deal — a natural gas deal that could be a huge investment opportunity.
A Historic Natural Gas Agreement
After a decade-long negotiating battle, Russia and China have finally signaled that they are going to be partners in one of the largest natural gas deals in history. The emerging market duo agreed to a 30 year natural gas deal that would send the fuel from Siberia’s Irkutsk Kovyktinskoye and Chayandinskoye natural gas fields via a new pipeline system into China.
That pipeline system — dubbed “The Power of Siberia” — will cost around $55 billion to construct. According to the agreement, Russia will send around 38 billion cubic meters of gas through the pipeline system per year. Exports will be begin in 2018 after the required midstream infrastructure is completed.
But again, the key to the deal was price.
That single issue had derailed the negotiations for more than a decade. But according to sources, China will now pay Russia around $350 per thousand cubic meters of natural gas. That’s in line with what European utilities pay Russia for their exports and below the cost of importing liquefied natural gas (LNG) into Asia.
At those prices, the deal is estimated to be worth around $400 billion — the largest energy contract ever awarded in Russia. Even aside from that potential award, the natural gas deal is a huge win for the overall Russian energy sector, mostly because it helps diversify the nation away from Europe.
Since its “invasion” into the Ukraine, the E.U. and United States has continued to ramp up sanctions and pressures on Russia. By signing the natural gas deal, Russia has single-handedly diversified itself away from those markets and puts the Kremlin back into the driving seat. It also helps strengthen the two BRICs’ economic ties and supports the duo’s recent agreements on other trade issues.
All in all, the historic gas deal could be one of the biggest profit producers for long-term investors and will certainly be one of the biggest drivers of future gains in Russia.
But what’s the best way to play the enormous energy deal? Well…
Two Prime Picks For The Natural Gas Deal
The new natural gas deal has the power to drive the Russian energy sector and overall economy, which makes it an obvious investment opportunity. A prime place to start is Russian natural gas giant Gazprom (OGZPY).
Thanks to its state-owned status, Gazprom has a virtual exporting monopoly on the fossil fuel in Russia. The firm will be the main supplier of natural gas and majority owner in the pipeline in the deal. That should translate to a long-term increase in OGZPY shares.
Yet OGZPY shares are currently cheap. Like, really insanely cheap.
Gazprom stock spent much of 2013 treading water as natural gas demand from Europe — its main source of revenues — remained flat. Adding in general Russian political risks and the issues in the Ukraine, downward pressures on Gazprom shares have been great. So great, in fact, OGZPY stock has a forward P/E of 2.8. That actually makes Gazprom the single cheapest energy stock out there — by a far margin.
Meanwhile, that cheapness doesn’t accurately reflect the potential of the historic China gas deal nor the fact that the pipeline system would feed into Gazprom’s LNG ambitions in Japan and South Korea.
If Gazprom moved to simply trade at price-to-earnings metrics similar to rivals such as Exxon (XOM), we’re looking at a $40-plus stock. That’s more than four times today’s selling prices.
If the risk of a single Russian stock is more than investors can handle, the Market Vectors Russia ETF (RSX) is a good substitute. The exchange-traded fund features Gazprom as its top holding and is 43% weighted in Russian energy stocks. That includes major positions in Russian giants Lukoil (LUKOY) and Rosneft (RNFTF). Overall, RSX allows investors to play the natural gas deal as well as future energy agreements between China and Russia.
The bottom line: The natural gas deal with China is transformative for the Russian energy sector. Investors looking to cash in on the deal of the century should focus their attention towards OGZPY or the RSX ETF.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.