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Buy Santos Limited and Oil Search Limited to profit from China’s pollution woes

Pollution is a massive problem in China! For those that can remember, the most significant recent report on China’s pollution was a 2007 report by the World Bank that made some startling discoveries and plagued the lead up to the 2008 Olympic Games. The report called for wide-spread changes due to the facts that, at the time:

  • 16 of the world’s top 20 most polluted cities were in China,
  • Of the country’s 560 million major city inhabitants, only 1% were breathing air considered safe by the European Union, and
  • Poor air quality resulted in nearly 800,000 premature deaths per year.

It seems that little has changed, a 2013 report found that air pollution levels in major cities were literally off the recordable chart, while clouds of Chinese air pollution have reportedly reached California and Alaska.

How does this impact Australian investors?

Excellent question! The most obvious answer I’ve found is that the latest crackdown on air pollution in China will start to hit coal producers in coming years. Coal, one of the worst fossil fuels for particulate emissions, currently accounts for around 65% of China’s energy needs. This is expected to fall to the low 50%-range by 2020, however it should be noted that it’s unlikely the actual volume of coal burnt will decrease much, just that the amount of other fuels used will increase as China’s energy use increases over time.

Naturally then, fuels that produce fewer emissions will be favoured. The top two that stand to benefit are Uranium, for nuclear power plants, and natural gas. Uranium prices have been depressed for a long time and excess supply shows little sign of being absorbed by the market, therefore I much prefer gas.

Natural gas, supplied in its liquefied form, known as liquefied natural gas (LNG) is set to be produced in huge quantities in the coming years from Santos Limited (ASX: STO) and Oil Search Limited (ASX: OSH). LNG power plants can cut CO2 emissions by up to half and significantly reduce sulphur and nitrogen dioxides, which are known to cause respiratory problems.

Santos is well placed to benefit from the start of production at its Gladstone LNG and PNG LNG projects between now and 2016, while Oil Search will also see a huge boost in revenue in coming years from its stake in the huge PNG LNG project.

These two will be in a position to significantly boost dividends and overall shareholder returns once these projects come online.

Foolish takeaway

Australian gas companies such as Santos and Oil Search stand to benefit in the next five to 10 years from the finalisation of long-term projects and increased demand from developing nations such as China. For long-term investors, now appears as good a time as any to jump in, just before this major production starts and revenues jump.

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Motley Fool contributor Andrew Mudie does not own shares in any companies mentioned. You can find Andrew on Twitter @andrewmudie

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