China's LNG Deals Under Strain as Demand Falls

An analysis by Michael Lelyveld
2015-07-20
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 Logo of a Sinopec station in Qingdao, Shandong province, in file photo taken June, 25 2011.
Logo of a Sinopec station in Qingdao, Shandong province, in file photo taken June, 25 2011.
AFP

Signs of trouble have been mounting for liquefied natural gas (LNG) suppliers with reports that China is seeking to revise major import deals.

Last month, the industry publication Petroleum Economist said that China's national oil companies were "desperately trying" to renegotiate LNG purchase commitments after domestic demand growth declined sharply last year.

Second-ranked Sinopec has reportedly sought new terms for deliveries from the U.S. $19-billion (118-billion yuan) Australia Pacific LNG (APLNG) project, which is shortly due to come on stream.

Sinopec has resorted to "various negotiating tactics," including "forced delays" in opening an LNG import terminal in south coastal Guangxi Zhuang Autonomous Region, Petroleum Economist said.

The company has committed to buying 7.6 million tons of LNG annually from the project led by Australia's Origin Energy, representing 88 percent of its contracted output, over a 20-year period.

Origin and U.S.-based ConocoPhillips each own 37.5 percent of the APLNG project. Sinopec is also a shareholder with 25 percent.

On June 29, Origin said it expects Sinopec to fulfill its purchase agreement, Bloomberg News reported, but the agency was unable to get a response from Sinopec.

Downward pressure

The Sydney Morning Herald cited reports that Sinopec may try to resell its LNG cargoes elsewhere in Asia, putting more downward pressure on already-low prices in the spot market.

But the company needs approval from project shareholders for any reselling. The agreement also includes a "take-or- pay" provision, making Sinopec liable for the cost of supplies, whether it accepts them or not.

The predicament prompted a Credit Suisse analyst to write in a research note that the chances of breaking the contract "may now be a non-zero risk," The Australian daily reported.

Analysts say market pressures have been building for months as a slew of LNG developments prepare for startup in Australia, including APLNG, the Chevron-led Gorgon and Wheatstone projects, and several others with more on the way.

"It has been clear for a year or more that the Australian projects were all coming on stream at a time of declining demand," said Philip Andrews-Speed, a China energy expert at National University of Singapore.

"Last December, there were already rumors that Sinopec was planning to sell on its contracted imports. So, these reports do not come as a surprise, and I would not be surprised if Sinopec seeks some deviation from its take-or-pay contract," Andrews-Speed said.

The pressures highlight the risks of long-term capital-intensive investments based on China growth forecasts.

China's rising gas demand has been the main motivator behind massive LNG investments, particularly in Australia.

If all of Australia's projects come on stream as planned, its LNG export capacity would more than triple by 2020 to become the largest in the world, putting it ahead of Qatar, Reuters estimated last year.

But Australia is not alone in facing the consequences of fading consumption growth in China after years of double- digit gains and forecasts of ever-increasing demand.

China imported nearly 19.9 million tons of the super- cooled LNG fuel by ship last year from 17 countries as supplies rose 10.3 percent following increases of over 20
percent in the previous two years, Interfax said.

LNG supplies to coastal cities supplemented pipeline deliveries, accounting for some 46 percent of China's gas imports and 15 percent of consumption last year, based on official reports.

While the government's anti-pollution campaign has spurred more demand for cleaner-burning gas, slower economic growth and cheaper coal have been holding it back.

In a report last month, the Paris-based International Energy Agency (IEA) said China's gas demand growth slipped to about 8 percent last year from an earlier five-year average of 14 percent.

Slower growth

Growth slowed further to 7 percent in the first quarter before turning negative with a 6-percent drop in April from a year earlier, Petroleum Economist said in another report.

China's gas consumption in the first half of the year rose by only 2.1 percent from a year-earlier to 90.6 billion cubic meters (3.2 trillion cubic feet), the National Development and Reform Commission (NDRC) planning agency said Sunday.

The prospects for a turnaround may depend on how quickly China pursues its new climate pledge to curb greenhouse gas emissions.

On June 30, the government set a goal for 2030 of reducing carbon dioxide (CO2) emissions per unit of gross domestic product (GDP) by 60-65 percent from 2005 levels, raising its sights from an earlier target of 40-45 percent.

The new numbers may brighten outlooks for global warming and gas demand growth, but since they are still tied to GDP performance, the effects remain in doubt.

Shortly before China released its new targets, the IEA dropped its medium-term forecast for the country's gas demand in 2020 by about 10 percent, citing the growth slowdown last year.

The estimate is 10 percent below China's official forecast and about 25 percent less than a more bullish supply target announced by the government in April 2014.

Since then, spot market LNG prices have plummeted, dragged down by a combination of factors including lower oil prices, the boom in U.S. shale gas, weak economic recovery in the West and slower Asian growth.

The relative prices of LNG and pipeline gas for China have now been reversed with most LNG cargoes landing in coastal cities at a cheaper cost, the IEA said.

On paper at least, the growing gas glut will not affect LNG ventures that have signed take-or-pay agreements with China at contract prices. But the recent reports seem likely to put pressure on contract terms.

For suppliers to China, the confluence of timing, market conditions and economic factors could hardly be worse.

In the meantime, China's energy giants seem to be pursuing growth agendas for gas use as if nothing has changed.

On June 29, state-owned China National Petroleum Corp. (CNPC) officially started construction of the 3,968-kilometer (2,465-mile) "East-Route Natural Gas Pipeline" from Siberia on Chinese territory, state media reported.

The project known in Russia as the "Power of Siberia" is scheduled to completed by end-2018, eventually supplying 38 billion cubic meters (1.3 trillion cubic feet) of gas annually. The volume would be nearly four times more than the supplies from APLNG.

Russia's ambitious Yamal LNG project has been negotiating with Chinese banks for up to U.S. $15 billion (93 billion yuan) in loans to produce 16.5 million tons of LNG annually, according to Interfax. CNPC holds 20 percent of the Arctic venture. Partners include Novatek of Russia and Total of France.

Last week, Sinopec won approval from China's State Oceanic Administration for a new LNG import terminal on Xiaomen Island, near Wenzhou city in coastal Zhejiang province.

China already has 12 import terminals with 15 others either approved or in construction, Reuters said.

On June 16, Reuters also reported that Sinopec "is on the hunt for minority investments in U.S. shale oil and gas projects" in order to diversify its supplies.

Sinopec wants to take a 10-15 stake in LNG export projects but has found the prices are "not low," a company official was quoted as saying.

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