China Reconsiders LNG Tariff Threat

An analysis by Michael Lelyveld
2018-08-20
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Trucks transporting liquefied natural gas are seen at Sinopec's Beihai LNG terminal in south China's Guangxi Zhuang Autonomous Region, July 24, 2018.
Trucks transporting liquefied natural gas are seen at Sinopec's Beihai LNG terminal in south China's Guangxi Zhuang Autonomous Region, July 24, 2018.
Reuters

China has sown confusion in international energy markets after reconsidering plans to slap tariffs on U.S. crude oil and liquefied natural gas (LNG).

The conflicting signals on China's energy imports reflect Beijing's uncertainty about the risks of retaliatory measures as it tries to match tariffs imposed by the United States in the escalating trade war.

The reversal also highlights China's concern about its growing dependence on foreign oil and gas with imports of crude now nearing 70 percent of the country's supplies.

But the U-turn on LNG tariffs may be particularly telling as China weighs the effect on its push to replace high-polluting coal with cleaner-burning gas.

The threatened tariff on LNG is likely to be a topic when a Chinese delegation visits Washington for trade talks later this month.

Although the United States supplied only about 6 percent of China's LNG imports last year, the volumes have been poised to climb with new development and terminal projects driven in part by China's growing demand.

U.S. volumes of the super-cooled fuel shipped to China through May more than tripled from low levels a year before, according to data from the Energy Information Administration (EIA).

LNG has been high on the agendas of both countries since the first meeting between Presidents Donald Trump and Xi Jinping last year, in spite of trade frictions.

"The United States welcomes China, as well as any of our trading partners, to receive imports of LNG from the United States," said a statement from the U.S.-China Comprehensive Economic Dialogue in May 2017.

In February, Texas-based Cheniere Energy signed two long-term contracts for supplying LNG to state-owned China National Petroleum Corp. (CNPC) over the next 25 years.

As recently as July, Chinese analysts predicted that the government would keep the LNG trade from becoming a casualty of the tit-for-tat trade war.

"If we impose tariffs on U.S. LNG, we pay a much higher opportunity cost," said Mei Xinyu, a researcher at a think tank affiliated with the Ministry of Commerce (MOC), according to Reuters.

"Duties on soybeans hurt the U.S. more, but duties on energy products would hurt both sides," Mei said.

A chill through the industry

But on Aug. 3, the ministry said it would include LNG on a U.S. $60-billion (412-billion yuan) tariff list in response to reports that Washington had considered plans to more than double tariffs on U.S. $200 billion (1.3 trillion yuan) of Chinese products from 10 percent to 25 percent.

The retaliation sent a chill through the U.S. LNG industry, which had assumed China would continue to exempt the investments in shale gas development and export terminals that it had previously encouraged.

Claudio Steuer, a senior visiting research fellow at The Oxford Institute for Energy Studies, said the tariff "will definitely price U.S.A. LNG completely out of the Chinese market," Bloomberg News reported.

Shares of U.S. LNG developers dropped on the news.

There were also reasons, however, to question whether China's move to punish LNG investors might work against its own interests.

The arguments against erecting tariff barriers to any LNG imports appear to have won out, at least for now.

On Aug. 8, the MOC issued a revised list of U.S. goods subject to tariffs, leaving off crude oil and LNG, although maintaining penalties on liquefied petroleum gas (LPG) and other fuels, the online pricing service Natural Gas Intelligence reported.

In light of the waffling back and forth, it is unclear whether the exception for LNG is permanent or how long it will last.

"LNG exports remain exempted from retaliatory measures, but that could change if the U.S. proceeds with a potential third tranche of tariffs in late September or early October," Argus Media said on Aug. 8.

China relied on imports for nearly 40 percent of its gas consumption last year, with inflows of 94 billion cubic meters (3.3 trillion cubic feet) divided evenly between pipeline gas and LNG delivered by ship from abroad.

LNG imports saw especially strong growth of 50 percent from a year earlier as China pursued plans to cut coal use and smog in Beijing and the surrounding region last winter.

Pipeline supply problems in Central Asia helped to push China into the high-priced spot market for LNG.

In the first half of this year, China's LNG imports outpaced pipeline deliveries by 30 percent, based on customs figures reported by oilprice.com.

Asian LNG traffic and spot market prices tend to peak in October and June with supplies for winter heating and summer cooling, tapering off in the "shoulder months" of lower demand.

This year, off-peak demand has been boosted by a record heat wave in Japan, the world's leading LNG importer. Faced with power shortages, Japanese utilities have reluctantly resorted to burning oil for its generation needs, Reuters said in a separate report.

The heat wave had a similar impact on South Korea, now the third-largest LNG importer after it was surpassed last year by China.

The liquefied natural gas (LNG) tanker Stena Blue Sky is seen at a new LNG terminal owned by Chinese energy company ENN Group, in Zhoushan, eastern China's Zhejiang province, Aug. 7, 2018.
The liquefied natural gas (LNG) tanker Stena Blue Sky is seen at a new LNG terminal owned by Chinese energy company ENN Group, in <br /> Zhoushan, eastern China's Zhejiang province, Aug. 7, 2018. Credit: Reuters
Not the best time

The conditions suggest that this may not have been the best time for China to impose a 25-percent tariff on U.S. LNG.

The potential downside for China is that it could find itself in competition for Asian LNG cargoes if supply and demand problems multiply as they did last winter.

China has been scrambling to open more LNG receiving terminals to add to the 20 now in operation. But the country's lack of adequate storage capacity may limit the amount of pre-buying it can do to prepare for winter.

The immediate reaction to China's first announcement on Aug. 3 was a relatively mild increase of U.S. 25 cents (1.70 yuan) in Asian LNG benchmark prices to U.S. $10 (68.70 yuan) per million British thermal units (MMBtu), a rise of about 2.5 percent. Asian spot market prices are the highest in the world.

Analysts say the effects of the tariffs were more likely to be felt over time.

"In the short term, the tariff would likely raise LNG prices," said Giles Farrer, research director of global gas and LNG supply at the international consulting firm Wood Mackenzie in a note cited by S&P Global Platts news service.

"Long-term market consequences are likely to be felt on new supply developments as it would restrict the target market for developers of new US LNG projects trying to find new long-term contracts," Farrer said.

Edward Chow, senior fellow for energy and national security at the Center for Strategic and International Studies in Washington, said the short-term effects would be limited by the flexible nature of the LNG trade.

"Once an LNG cargo is on the water, it is essentially fungible," Chow said. "A U.S. cargo that doesn't go to China will go elsewhere, while cargoes previously destined for elsewhere will go to China instead."

With tariffs, China may have had to pay "a slight premium," said Chow.

The greater significance of tariffs is that they would keep Chinese buyers from making long-term purchase commitments to new U.S. LNG capacity, which the projects need to obtain financing, he said.

Without contracts, China would have to rely more on the uncertain prices of the spot market if it gets into a bind.

"As a rapidly growing LNG market, it is in China's interest to see new projects go forward," Chow said.

On Aug. 12, Bloomberg reported that CNPC's PetroChina may temporarily stop purchases of U.S. LNG spot cargoes through the winter, apparently reflecting concerns that tariffs could be assessed at any time.

The company would boost spot buying from other countries or swap U.S. shipments with other nations to avoid paying tariffs, the report said, citing sources "with knowledge of the strategy."

Reshuffling LNG supplies

Mikkal Herberg, energy security research director for the Seattle-based National Bureau of Asian Research, agreed that the effect of imposing tariffs on a single LNG producer would likely be limited, given new production in other countries including Papua New Guinea, Russia and Australia.

"This could raise spot prices in the region but likely only for a short period as LNG supplies reshuffle and the market settles out," he said.

Herberg noted that the sharp rise in China's LNG prices last winter was due in part to gas shortages that were intensified by pipeline problems. These are unlikely to be repeated, since Central Asian suppliers are planning to increase deliveries this year, he said.

But China's reluctance to impose tariffs on U.S. LNG imports suggests the government is unwilling to take the risk of contributing to potential shortages.

With or without tariffs, China has shown that it is willing to pay high prices if necessary to meet demand and pursue its anti-smog policies.

"They have paid really high prices last year when necessary," Herberg said.

LNG prices for China reached a high of U.S. $11.70 (80.40 yuan) per MMBtu last winter, S&P Global Platts said.

CH. 1: MANDARIN | CANTONESE

CH. 2: VIETNAMESE | BURMESE | KOREAN

CH. 3: KHMER | LAO | UYGHUR

CH. 4: TIBETAN

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