How to Profit from China's Massive Oil Deal in Australia

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A $15 billion deal for liquefied natural gas (LNG) involving Australia, China and global-oil heavyweight Exxon-Mobil Corp. (NYSE: XOM) has prompted many investors to worry that China may be using its global-markets muscle to “paper over” cracks in the global economy.

In reality, however, this mega-deal is a harbinger of what’s to come, and highlights the road that global investors must travel in their journey to maximize their own investment returns.

If you feel like you need a guide on that journey, just look to Australia. That country seems to be setting the pace when it comes to obtaining both a way out of the global financial crisis and an important new trading partner that could benefit their nation for years to come. What’s happening there could be a model we’d best learn from.

As we have noted repeatedly here at Money Morning, when China buys, it buys big. Most recently, China’s global resource acquisition spree has centered on Australia (after tours through Canada, Africa, the Middle East and South America).

By some accounts, the timing couldn’t be better. Following the recent arrest of four Rio Tinto PLC (NYSE ADR: RTP) employees in China last month on corporate espionage charges, the two countries needed to do something mutually beneficial to smooth over relations. For China, the acquisition is viewed as a way to save face and further its strategic interests. For Australia, this deal is a source of cash that will flow right into the government coffers and help the country rebound from the global financial crisis.

The transaction involved a place most people here have never heard of – Barrow Island. Located about 30 miles off the northwest coast of Australia, and about 80 square miles in size, Barrow sits atop a supply of natural gas – a portion of which that will now be liquefied and sent to China.

According to the terms of the deal made public recently, Australia is going to process and ship some 15 million metric tons of the fuel each year – enough for this deal to be worth roughly $15 billion over the life of the contract.

Development of the project is expected to create 6,000 jobs initially, with another 3,000 to follow. It’s also expected to yield some $6 billion for the Australian government, which – like most governments around the world – can really use the money, since it’s still struggling to come to terms with the global financial crisis.

Not surprisingly, like most deals involving China these days, this one has sparked controversy on a number of different levels.

Naturally, there are the obvious environmental issues. According to conservationists, Barrow Island is home to a number of endangered animals, which is why environmentalists are pushing for the liquefied natural gas plant to be built on the mainland.

But Australian Environmental Minister Peter Garrett dismisses that notion. Speaking to various Australian media outlets, he’s stated that he doesn’t believe there will be “unacceptable impacts.”

As you might expect, that’s ignited a firestorm – akin to the environmental debates we’re used to seeing in this country. Australian Sen. Bob Brown, leader of the “Greens” party, groused that Canberra has put economic interests ahead of those of wildlife and the environment.

What makes this transaction important – and worthy of study – is that the deal is a window into the future. In an increasingly global economy, as mega-dollar international deal proposals become more and more commonplace, the players will have to find a way of addressing the inevitable political battles.

And that’s particularly true when one of the parties is China (as will also be the case on an increasing basis). With the LNG deal, the ink had barely tried before Australian Labor representatives were leveling charges that Canberra’s conservatives had sold out. Many, who seem to feel that a pact reached with China is tantamount to making a deal with the devil, are saying that the diplomatic cost of doing business is steamrolling the concepts of human rights and democracy. But others view such a transaction in much more pragmatic terms.

After all, they say, $6 billion is still $6 billion.

This is not a simple issue and it’s complicated by the fact that China sits on the world’s largest pile of excess reserves – more than $2.3 trillion by some estimates. And the Asian dragon is going to spend or invest that capital as it sees fit, no matter what happens with the U.S. dollar, Western budget deficits, or the global economic recovery.

And it’s not because China wants to spend this money … it’s because China has to spend that money. It’s a matter of the country’s long-term survival.

As we have said a number of times here in Money Morning, China must engage in transactions beyond its borders to ensure that it continues to have borders. Deals like this are not about world dominance. They’re aimed at avoiding “social unrest” – the two-word phrase that scares Beijing more than anything else.

This is why Chinese leaders have been so resolute in their drive to lock up supplies of raw materials and other key commodities.

For the most part, governments are caught between citizens who get uncomfortable at the thought of selling valuable national interests to a trading partner they don’t really know or understand and their own corporations, which desperately need two things to maintain their own global competitiveness: access to China’s low-cost manufacturing capacity, and market share (revenue) from what is the fastest-growing market on earth.

To be better able to deal with – and feel comfortable about – what’s transpiring in an increasingly global marketplace, Westerners need to start understanding what’s really at stake. And they need to also dispense with their own misperceptions.

Take the whole Unocal Corp. transaction of 2005. It failed because U.S. interests were appalled that a Chinese company could acquire “national interests.” Yet few took the time to understand that most of Unocal’s assets are actually located in Asia — which is why the Chinese tried to buy it.

For instance, not only did the United States slam the door in China’s face when China tried to buy Unocal Corp. Chinese National Offshore Oil Corp., or CNOOC (NYSE ADR: CEO) tried to acquire Unocal for $16 billion to $18 billion. Following a vote in the U.S. House of Representatives, the bid was referred to U.S. President George W. Bush. The reason: The deal was said to have “national security” implications. CNOOC withdrew its bid and Unocal subsequently merged with Chevron Corp. (NYSE: CVX).

Then there’s the whole human rights argument, which inevitably comes to the front of the line whenever China is involved in a deal. Detractors logically highlight the fact that China’s record doesn’t fit with our own. Yet, in doing so, they forget the West’s history. The high and mighty, history reveals, weren’t always so high and mighty. In short, we’re not perfect, either.

On one hand we espouse free markets and the premium of economic choice. So why is it that we can’t stand to have the tables turned when it comes to China’s economic freedom? The West has engaged in direct economic investment abroad for years. Shouldn’t China be allowed to do the same thing?

Then there are the concepts we’ve used to justify our own actions particularly when it comes to foreign direct investment. We’ve argued (and continue to argue) that our investments in distant locales will help spread democracy, improve human rights, nurture educational excellence and contribute to the free-market efficiencies that will allow the global economy to function much closer to peak efficiency. And we’ve used the increase in taxable revenue, local employment and even training as reasons to justify our actions and our interests.

If you adopt an objective, global perspective, and see things as China does (understanding its general objectives in the process), there is really only one conclusion a U.S.-based investor can reach: The changes under way are inevitable. Fight them, if you must, but realize it’s at your own cost, and understand the once-in-a-lifetime investment opportunities you’ll be missing.

Or embrace them and ride along – which is not only the path of least resistance: It’s also the most profitable trail to take.

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