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China and Iran: Oil in the Desert

Posted December 18, 2007

"Both Iran and China could take their toys and go home at any moment in today's political climate. And that huge oil and natural gas contract is based on the idea that China will keep growing enough to consume energy at a faster rate each year." — Stephanie Grimmett

by Stephanie Grimmett

Baltimore – (TFN) Energy needs make for strange bed fellows. Witness the new and loving relationship between communist and officially atheistic China (remember, it's the country whose leader referred to religion as a disease) and militantly Muslim Iran.

You can only imagine the philosophical justifications being handed to small Chinese children about Iran's true communist and/or atheist roots as we speak. And I'm sure the Iranians hope to someday bring the Chinese to God.

China fulfilled a four-year-old agreement with Iran late last week, when the country's Sinopec, a.k.a. China Petrochemical Company, (SHI: NYSE) signed a deal with Iranian officials to tap into Iran's Yadavaran oil field.

The initial set up for the oil field will cost about $2 billion. And production should start in 2009.

Yadavaran has the potential output of 300,000 barrels per day, with total reserves of 3-18 quintillion (that's 3-18 with 18 zeroes after it, or a billion times a billion) barrels of oil and 80 billion cubic meters of natural gas.

Along with drilling the field, China's petroleum companies have agreed to buy 400,000 barrels of oil per day from Iran in 2008. The Chinese will also purchase about 11 million tons of liquid natural gas from Mahmoud and Co. each year through 2033.

Based on the 2004 deal, Sinopec would pay Iran up to $100 billion for liquid natural gas and oil and a 51% stake in Yadavaran, a field that, according to today's prices, is worth anwhere from $270 quintillion to $1.6 sextillion, both numbers so large they're incomprehensible. Think of them as $270 billion times one billion and $1.6 trillion times one billion, to get a better handle on the size.

But I wouldn't pile my money into Sinopec just yet. The share price jumped on the announcement. But the stock has already dropped to preannouncement levels again. And it doesn't look like the market knows what to make of the situation.

Both Iran and China could take their toys and go home at any moment in today's political climate. And that huge oil and natural gas contract is based on the idea that China will keep growing fast enough to consume energy at a faster rate each year.

Some strong growth is still left in China, but I wouldn't depend on a drilling contract that won't even begin paying off until 2009. A lot can happen in the next year. We still have the Beijing Olympics to survive — by that, I mean the economy must survive, not the participants, although I'm not too sure about the odds on some of them, either. And the Chinese economy must weather attempts by its own government to slow it down.

As Chinese consumption replaces Chinese production, in other words, as the economy matures, I wouldn't be surprised if the Chinese energy monster isn't growing as quickly anymore.

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Posted by Stephanie Grimmett · Filed Under Oil and Energy 

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